Congratulations on making the right choice to venture into investing. When you spend so much of your day working so hard that you’re able to have quite substantial savings, you just wouldn’t want to put this all together in just one place. Although your money is safe in a bank, you also need to learn how to diversify your portfolio—this means learning to put your assets in other areas where it can grow, one of which is investments.
If you’re a first-timer, let’s not sugarcoat the fact that investments can be quite tricky. There’s just so much for you to learn so you can be sure that you’re not making the wrong decision. Even the most seasoned investor will still have a lot to learn about asset allocation analysis.
The article talks about everything you need to know regarding asset allocation when investing.
The Basics of Asset Allocation
Asset allocation is a very important skill to master when it comes to investments because not all investment opportunities are equal. There are instances when one asset can increase in value, but another will also increase. Asset allocation is the best protection that an investor can have against any possible major losses.
The key is for you to balance your allocation of assets between low- and high-risk stocks, short- and long-term bonds, and even cash, for some.
How to Optimize Asset Allocation
When it comes to investments, you may have heard of the advice never “to put all of your eggs in one basket.” This is what the bulk of optimizing asset allocation means. When choosing which assets to allocate in certain investments, don’t put all of your savings or assets in just one investment opportunity—this is would be too risky.
Rather, you should learn how to allocate your assets into these classes: money market securities, stocks, bonds, and cash.
Going even more specific, these asset classifications can also be further refined into:
- Large-cap stocks, which is only for large corporations as it has quite a hefty asset capitalization requirement;
- Money market, refers to the investments in short-term debt usually for a year or less, with treasury bills as the most common type;
- Mid-cap stocks, also beneficial only for large corporations.
The Two Most Important Factors Regarding Asset Allocation
Setting aside your personal preferences, there are generally two basic factors you’ve got to consider. These are:
- Risk Tolerance. The risk tolerance here refers to that which an investor can handle. Putting it simply, this refers to an investor’s willingness and ability to lose sometimes, and win sometimes. It’s all a game of risks, with the hopes of gaining higher returns in exchange.
- Time Horizon. This factor refers to period until which your decisions on asset allocation is dependent on your financial capacity. The decision here will also depend on the main purpose you have for investments. For example, if you’re a parent looking to save for your kids’ education, you can opt for short-term investments. On the other hand, if you’re looking for investments for your retirement, the time horizon is more long-term.
The Importance of Risk vs. Return
Proper asset allocation is largely based on a risk and return balance. Every investor deciding on how to allocate the right assets is always driven by the desire to have high returns. However, it’s wrong to be fully controlled just by this. You’ve got to remember that high returns also come with extremely high risks.
For instance, you’ve got to learn how to read financial projections in the economy where your assets are based. If there’s any possible prediction of a financial crisis, then it’s not best for you to be aggressive right now.
A Conservative Portfolio is Best for Beginners in Asset Allocation
If you’re still a beginner and you aren’t that well versed with asset allocation, now’s not the best time for you to be aggressive. Give yourself some time to learn more about the different investment opportunities, so you’re sure that you’re selecting the right options.
Hence, for starters, a conservative portfolio is the best choice. This means allocating a majority of your assets to the lower-risk investments, such as money market securities.
The Importance of Asset Allocation
Asset allocation is very important for one paramount purpose: reducing risk. When you allocate your assets on different investment classes, you’re technically diversifying. This can give you a sense of security, just in case one type of asset will suddenly become more speculative and dangerous.
Note that different investments don’t move together. When some are better than others, you need to give yourself that balance. In case of any losses, you’ll have wins through other investments that can offset what you just lost.
Now that you’ve got a clear idea on what asset allocation is all about, the hope is for you to learn how to divide your investments into different profitable types. There’s no one mode of allocation that works to be the best for everyone. You’ve got to create that balance between your needs, preferences, and even your personal financial goals. Over time, when you’ve practiced stable asset allocation, you’re guaranteed a higher chance of financial success.