You may have heard this term before, but what is asset allocation, how does it work and are all strategies the same? We’ll walk you through everything you need to know to get the most out of your portfolio.
Definition of asset allocation
Asset allocation is the selection or combination of investments between different asset classes . These can be stocks, fixed income instruments (bonds), cash or non-traditional investments (real estate or commodities).
Fundamentally, asset allocation is about choosing the right type or mix of investments for your portfolio to keep your financial plan on track – ensuring you get enough return to meet your goals and a level of risk you can afford. you can endure without changing your savings habits or investment strategy. Although an important aspect of investing, asset allocation can be complex and time-consuming, which is why many investors turn to professional managers or advisors for advice. .
The importance of diversification
The main benefit of asset allocation is that it spreads your money across different types of assets to give you diversification . When your portfolio is diversified, it helps protect your investments against declines or fluctuations in one part of the market, while providing exposure to the growth or returns of other parts.
Suppose your portfolio consists of stocks, cash and real estate. One day, the stock markets take a downturn and the value of your shares drops. Although this part of your portfolio may experience negative returns, you always have money invested in cash and real estate to prevent your overall portfolio from being negative.
Find the right asset allocation
To find the right asset allocation or “ mix ” for your portfolio, ask yourself four questions:
If you’ve just started working and want to start saving for retirement, your investment horizon is likely longer. This means you can give more weight to riskier asset classes like stocks or alternative investments. However, if you’re saving for a home you want to buy in a few years, with less time to make up for any losses, fixed-income securities or cash may be better suited to protect that down payment.
Whatever your goal, the key is to maintain the right spread (diversification) to maximize returns at the level of risk that is right for you and that you can afford.
Strategic Asset Allocation
Strategic asset allocation takes a long-term approach to defining your asset mix. It encompasses factors such as historical asset class performance, long-term market risks and opportunities, to name a few. Objectives are set for the allocation of each asset class in the portfolio to ensure that investors achieve their financial objectives within their time horizon and the desired level of risk. For example, in the case of a more aggressive portfolio, 50% of the assets will be allocated to equities, 20% to alternative investments and the remaining 30% to fixed income securities or cash.
The portfolio will generally be rebalanced periodically (ie quarterly or annually) to keep asset class weightings in line with strategies or objectives. So, using the previous example, if the share of equities reaches 55% of the portfolio, 5% will be transferred to fixed income securities to bring the allocation to 50% and 30%, respectively.
Tactical Asset Allocation
Tactical asset allocation also takes into account the long-term strategic approach, but offers the possibility of making small “tactical” adjustments depending on short-term economic or market conditions. A tactical shift could be made in the portfolio to deviate slightly from the original asset allocation to take advantage of market opportunities, reduce risk and ultimately create additional value for investors.
Incorporate asset allocation into your portfolio
Do you want to incorporate asset allocation into your portfolio? At CI Direct Investing, we believe that the mix of assets is the most important driver of portfolio performance. That’s why we follow an investment strategy that aims to do just that: invest our clients’ money across a diverse set of asset classes to maximize returns at specified levels of risk.
Even better, you can access our asset allocation strategies through a variety of portfolios to suit your needs and preferences, from low-cost ETF portfolios, to portfolios exposed to private investments, to socially responsible impact investing and more.