Asset Allocation: The Key to Long-Term Investment Returns
Watching the roller coaster ride of the stock market can make many investors queasy. Even though the stock market has, historically, always trended up, investors can’t help but feel uneasy as they watch the values of their portfolios rise and fall with the market. When portfolios are limited to one type of asset, its value will reflect the volatility of that asset class. But, when portfolios are allocated among several different asset classes, the variable rates of volatility and the uncorrelated movements of each can have the effect of stabilizing the overall portfolio.
Asset allocation is a strategy involving the selection of a variety of asset classes to create a diversified and balanced portfolio to match your specific investment objective and risk tolerance. The principal behind it is that all asset classes don’t move in concert, rather, they move in different directions at different times, influenced by different aspects of the economic cycles. For example, stocks prices tend to go up when bond prices go down. No one can predict when price movements will change, so the best course is to have some exposure to multiple asset classes. Asset allocation can reduce the overall volatility of a portfolio and reduce market risk. But, investors also need to be aware of other types of investment risk that can impact their portfolio. Portfolios that aren’t protected against the risk of inflation, or interest rate risk, or tax risk can see their values adversely affected over a period of time. A well-balanced and properly diversified allocation of assets can address all of these risks.
Your own asset allocation strategy should reflect your personal investment objectives and your risk tolerance. There is no one-size-fits-all mix of assets that works for everyone. When developing your asset allocation, you need to consider these key factors:
- Investment Objectives: Are you seeking capital appreciation or income from your investments?
- Risk Tolerance: Are you willing to lose any portion of your investment in return for a larger gain?
- Time Horizon: How long are you able to commit to your investment strategy?
- Taxation & Inflation: The effects of both can minimize returns.
Things change over time. Certainly your financial situation will evolve and your attitudes and outlook will change. Your asset allocation strategy should be reviewed and updated regularly to reflect your evolving situation.