Strengthening Your Financial Portfolio through Asset Allocation and Diversification
In order to be successful in reaching your long-term financial goals, it is best to implement a varied approach that considers both strategic asset allocation and diversification. With the help of an experienced Financial Advisor, you can review your financial portfolio to see if your current investment strategy incorporates both.
Understanding the Basics of Asset Allocation and Diversification
Before you can properly allocate and diversify your portfolio, you must understand what the basic principles encompass. Asset allocation aims to balance risk by dividing an investor’s assets among three major categories – stocks, bonds and cash.
Each type of asset has a different level of return and risk, so each will impact your portfolio differently. Asset allocation takes into account the different ways stocks, bonds and cash have performed historically and uses those characteristics to improve the chances of achieving a desired total return over the long term. Asset allocation allows you to distribute your investments among the different types of assets to varying degrees. A solid asset allocation strategy balances riskier investments with steadier investments, and balances short-term with long-term investments. For example, allocating some of your investments into an emerging technology company (higher risk) while also investing some of your assets in government bonds (lower risk) balances riskier investments with steadier investments.
There are several benefits to the implementation of a sound asset allocation strategy:
- Reduces volatility over time: Stocks, bonds and cash generally do not gain or lose value concurrently. Having all three in a portfolio can help reduce volatility over time by offsetting setbacks in one category through gains in another.
- Helps protect against losses: The core of an asset allocation strategy is based on risk versus return. While some investors believe asset allocation is an investor’s way of settling for mediocrity, most financial experts will argue that a set allocation is a good protection against major losses, especially if one asset class suddenly takes a dive.
- Works in bull and bear markets: Rather than “putting all of your eggs in one basket,” using an allocation strategy that is designed so different investments respond to the market at different times will help improve the chances that your portfolio will be able to weather an economic downturn.
- Can help increase returns and decrease risks: By understanding the risk-return characteristics of various asset classes, allocating the right asset can help decrease risks and increase returns. For example, a money market or government treasury generally offers lower risks and returns, while small cap equities will have higher risk but also the highest return potential.
Strategically dividing assets between stocks, bonds and cash is only half the battle. You also have to properly diversify within asset classes. Within the equity portion of your portfolio, you have to decide the right balance of investments in small, medium or large companies. With bonds, you need to know which bonds you want to invest in and how much to invest in each. Whether you select investment-grade municipal securities for their safety and tax-advantaged income stream, or corporate bonds because they often offer a higher yield (in exchange for greater risk), proper diversification can help to eliminate dangerous concentrations in any one particular security, sector or style. This helps you to avoid an investment strategy where you rely on timing the market’s ups and downs – often a losing strategy.
Creating a Financial Assessment Routine
Here are some points which can help you better assess your financial portfolio and strategy:
- Conduct a financial review: Examine your current financial situation, including all of your assets and liabilities. Keep in mind that an investment, such as home ownership, may seem like a liability because of your mortgage payments, but the equity you’ve built can be counted as an asset.
- Determine your risk tolerance: Dividing your assets into different investment sources involves some financial risk. Your risk tolerance depends on several factors including your goals, age, income and personality. You’ll want to work with your Financial Advisor to determine your risk tolerance.
- Think about your future financial goals: By considering what you’d like your financial future to look like, you can devise a strategy to help you achieve those goals. Whether your focus is on retirement, travel, a second home or education for your children, your Financial Advisor can help you plan accordingly.
Securing Your Financial Future
Proper asset allocation and diversification are keys to a long and successful financial future. As with starting any new routine, get advice from an expert. Your Financial Advisor can help you develop a well-tailored investment strategy, select the right investment vehicles that align with your financial goals, and together you can develop the discipline and consistency needed to build and strengthen your financial portfolio.
Asset Allocation and Diversification do not assure a profit or protect against a loss in declining markets.