Why Have an Asset Allocation Strategy?
Your asset allocation strategy represents your personal decisions about how much of your portfolio to allocate to various investment categories, such as stocks, bonds, cash, and other alternatives. When stock market returns were above average for an extended period, investors did not have much interest in asset allocation. Then, the best strategy seemed to be to only own stocks. But investors are again focusing on asset allocation.
Some of the advantages of an asset allocation strategy include:
- Providing a disciplined approach to diversification. An asset allocation strategy is another name for diversification, an important strategy for reducing portfolio risk. Since various investments are affected differently by economic events and market factors, owning a variety of investments helps reduce the chance your portfolio will be adversely affected by a particular risk type.
- Encouraging long-term investing. An asset allocation strategy is designed to control your portfolio’s long-term makeup. It should not change based on economic conditions or market fluctuations.
- Eliminating the need to time investment decisions. Market timing is a difficult concept to implement. Not only do investment professionals have a difficult time accurately predicting the market’s movements, but waiting for the perfect time to invest keeps many on the sidelines. With an asset allocation strategy, you don’t have to worry about timing the market; you just have to ensure your investments stay within the proper percentages.
- Reducing the risk in your portfolio. Investments with higher returns typically have higher risk and more volatility in year-to-year returns. Asset allocation combines more aggressive investments with less aggressive ones. This combination can help reduce your portfolio’s overall risk.
- Adjusting your portfolio’s risk over time. Your portfolio’s risk can be adjusted by changing allocations for the different investments you hold. By anticipating changes in your personal situation, you can make those changes gradually.
- Focusing on the big picture. Staying focused on your asset allocation strategy will help prevent you from investing in assets that won’t help accomplish your goals. Rather than investing in a haphazard manner, it gives you a framework for making investment decisions.
Your asset allocation strategy will depend on a variety of factors unique to your situation, including your risk tolerance, return expectations, investment period, and investment preferences.