- Posted by Michael Pennartz
- On July 15, 2018
- 0 Comments
Asset allocation is a smart wealth-building strategy that divides an investment portfolio among different asset classes. For example, a sum of money can be divided among stocks, bonds, or cash investments in different amounts. The reason behind this strategy is to minimize the risk involved in the event of political or economic events that may affect the market. It is important to note that your financial needs may change over time and this will also affect your financial goals. Many of the same financial strategies you use when running your business can be applied to your personal finances, but we sometimes forget those principles when we get home from work. At National Business Helpers, we offer our clients a variety of business financing options, and expert advice for financial success.
Asset Allocation Considerations
- What is your timeline for your investment? Consider whether you need a return in months, years, or decades. Making this decision in advance will help you decide on the ideal asset allocation for this particular stage of your life.
- What is your risk tolerance? How big or small of a risk are you willing to take? If you’re comfortable with losing some or all of your original investment, or if you cannot afford to take a major risk, these considerations will help determine your asset allocation.
You have a set dollar amount you’re willing to invest. But you don’t want to put it all in one asset class or sector and you want to minimize your risk. So, you put some in X investment, more in Y investment, and another portion in Z investment. This is the process of diversification. A smart strategy is to mix up the types of assets you are investing in reduce risk and volatility and to diversify among different investments in each asset class. It’s rare for stocks, bonds, and cash investments to move up or down together at the same time. Therefore, consider investing in different asset classes (and more, such as real estate, precious metals, etc.) and consider diversifying your investment within each class. For example, take the allotted amount for stocks and further divide it among industries, such as healthcare, technology, construction, etc. This way, you further protect your investment from downturns unique to one particular sector.
A simplified way to ensure diversification is to invest in a mutual fund or exchange-traded fund. Mutual funds are run by a management company that invests money from numerous investors into stocks, bonds, and other investments. In a 2013 letter to shareholders, Warren Buffett offers the following sage wisdom on how he is planning to divide the assets in his will: “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund… I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
It is important to understand the fees and strategies of each of the funds where you choose to invest, as some funds are highly concentrated in one sector or industry and others carry very high management fees that may not
After a few years in the investment game, you may note that one investment is doing quite well, while others are doing quite poorly. Rebalancing is a way to get your portfolio back on track to ensure an equal and stable investment strategy. There are three main ways to rebalance:
- Sell. By selling some investments that are overweight, you can then invest in some that are underweight.
- Buy. Purchase additional or new stocks, bonds, or other investments in underweight
- Alter contributions. As you continue to add money to your portfolio, you can allocate some of your investing dollars to underweight asset classes.
It is important to note that there may be additional taxes or transaction fees associated with rebalancing. It’s best to consult with a financial professional who can help you determine the best way to rebalance the portfolio with minimal risk and the fewest additional fees or taxes as possible.