“The difference between success and failure is not which stock you pick or which piece of real estate you buy, it’s asset allocation.” Tony Robbins
In a nutshell, what is asset allocation?
Asset allocation is the process of deciding where to put money to work in the market. It aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance, and investment horizon. The three main asset classes—equities, fixed-income, and cash—have different levels of risk and return, so each will behave differently over time.
Trying to select the right asset allocation that maximizes your return, while limiting risk can certainly be a challenge. So, the question becomes how do you figure out which asset allocation bis right for you. Below we identify four points that we feel are important when thinking about asset allocation.
1. Risk vs Reward
What really is risk vs. reward? Simply put… it’s knowing what you own and why you own it. In other words, if you need income, then you probably don’t want a portfolio of non-income producing assets. While the returns may be higher, it doesn’t meet your need for a consistent flow of income and can put your principle at risk of greater loss. While we all like to talk a good game at a cocktail party, investing is about meeting your needs not some else’s. You drive a Buick because it is an enjoyable ride. While a Porsche may get you there faster, you may not get to enjoy the scenery along the way or once you get there. And vice versa. Know what you own and why you own it.
2. Define your goals, needs and expectations.
Most investor don’t do this but It’s important to create an Investment Policy Statement (IPS). A short one-page document that outlines:
- What your goals are…saving for a house, retirement, etc. Note, you can have multiple goals at one time.
- What are my needs? More income? Etc. And finally,
- What are my expectations? How much return on my investment do I expect? How much downside (loss) am I willing to tolerate.
I also suggest that you state what you’re not willing to do to reach those goals. For example, go in debt, trade options, or penny stocks.
Access it once a year. As your life and expectations change, so will your IPS.
3. Father Time is on your side.
While starting early is always better, starting any time is better than not at all. While your age and time horizon should play a role in the decision making on your allocation, there is not an absolute answer here (such as the old 100 minus your age rule). For example, you are 60 years old. So, you would subtract 60 from 100 which gives you 40. With this formula, 40% of your portfolio would be allocated to stocks and 60% to bonds. While this can be a guide to figuring out your allocation, a lot depends on your risk tolerance, market conditions, etc. Bottomline – Young or old, the longer you invest, the better off you will be.
4. Set it in motion
Very often, the facts may be clear, but you fail to act. As a result, you lose valuable time. In the financial markets, time means money. So, once you come up with a plan, execution of it is the key. Sometimes analysis is paralysis. Thus, trust in yourself and move forward.
The Last Word
While there may be no single solution to finding the right asset allocation for your portfolio: there are solutions. It is all about:
- Understating what you own and why you own it,
- Come up with a plan,
- It’s never too late to start,
- Set it in motion.
Asset allocation is not a one-time event, it’s a life-long process of progression and fine-tuning.
If you feel you need the help of a financial expert, then seek it. Sometimes it helps to talk all this over with some else to make sure you’re on the right track.