Asset allocation is an investment strategy that involves dividing your assets based on your target, risk tolerance, and length of the investment. You can apportion your resources to categories, such as cash, bonds, real estate, stocks, and derivatives, that have varying levels of return and risk leading them to behave differently over time.
While this strategy is executed differently for various individuals, it’s deemed as one of the most critical financial decisions that investors make. This implies that the choice of individual securities is second only to the way that these assets are categorized in cash, stocks, and bonds or other equivalent derivatives.
Here are some advantages of asset allocation that’ll convince you to make the most of this investment tactic:
- Diversification
One of the primary advantages of asset allocation is that you get visibility and access to various asset classes at all times. The diversification of your portfolio allows you to enjoy the perks that entail different types of investments; each of which performs best at a particular economic cycle, while underperforming at some point. This characteristic ensures that you benefit from exposure to various assets at all times.
These are the different types of investments you should know about:
- Stocks – You get this asset when you put money into a specific company. Essentially, when you buy shares, you’re getting pieces of that organization’s earnings and assets. Businesses sell stocks to raise funds. Shareholders get money by selling the stock for a higher price when its value increases. Another way to earn through this investment is through dividends, which the company regularly distributes to investors.
- Bonds – With this type, the bond issuer loans the money that you invested for their venture and repays the credit with interest. These investments have fewer risks, but also lower returns than stocks. You earn regularly through the organization’s payments.
- Mutual Funds – If you aren’t too keen on having to go through the trouble of finding the right combination of assets, mutual funds enable you to buy different investments in just one transaction. These organizations pool money from investors and use that amount to buy stocks and bonds through a professional manager. You earn through stock dividends or bond interest.
- Risk Reduction
There’s a saying that cautions investors in putting all their eggs in one basket. Having a diverse investment portfolio allows you to minimize the risks of losing money.
As mentioned above, different asset classes do well during specific economic cycles, but they also have times when their value goes down. This means that, when you put money into stocks, bonds, and other cash equivalents, you don’t limit your asset’s growth to one risky security. Instead, you’re dividing them into risky and non-risky ventures across classes.
Research and know the ins and outs of the market. You should at least have basic knowledge of the jargons and processes of this venture so that you can monitor the market and reallocate resources when needed, especially when the risks have become too high for your age or investment temperament.
- Protection from Volatility
Asset allocation also offers some kind of protection against the market’s volatility, which largely depends on investors’ emotions. Volatility pertains to price movement both high or low and how rapidly they swing back and forth. You can witness this characteristic in the stock market and, more recently, with cryptocurrencies.
Some types of volatility include:
- Price – One of the primary causes of price volatility is the emotional response of traders to a product or service’s supply and demand.
- Historical – This one looks at how often a stock’s price has moved over the past months or years. If the asset’s value has varied extensively within 12 months, this investment is deemed high-risk.
- Implied – Implied volatility pertains to an asset’s anticipated price movements by options traders. Check the futures options prices. If they start to rise, implied volatility is increasing.
- Freedom from Timing Investment Decisions
The asset allocation strategy eliminates the need for you to time your investments. You no longer have to monitor the market and wait for the optimal times to buy or sell. A diverse portfolio based on your target and risk tolerance will make investing stress-free, at the same time, enjoying the accumulation of wealth that comes with it.
Conclusion
Asset allocation is a wise investment strategy that entails having a diverse portfolio. A combination of stocks, bonds, and cash equivalent investments can lower the risk of losing all your money in a single risky security while protecting you from volatility. Plus, you’re also not restricted by time when it comes to investment decisions.
