Asset allocation is the process of selecting a mix of asset classes that closely matches an investor’s financial profile in terms of investment preferences and tolerance for risk.  It is based on the premise that different asset classes have varying cycles of performance, and that a diverse portfolio will be better equipped to withstand adverse market movements. All investments involve some sort of risk, but an individualized asset allocation strategy seeks to mitigate the risks of any one asset class though diversification and balance.

Individual Strategy

When done properly, an investor’s allocation of assets will reflect his desired goals, priorities, investment preferences, and his tolerance for risk. Asset allocation is an individualized strategy, so there really is no "perfect" mix of assets.  Each individual’s strategy is built on the careful consideration of the key elements of his or her financial profile:

Investment Objectives: What the investor hopes to achieve using his investment dollars – improve current lifestyle, achieve capital growth, fund a specific goal (such as a college education).

Risk Tolerance: This reflects the investor’s comfort level with market fluctuations that can result in losses.  Inflation risk and interest rate risk need to be considered as well.

Investment Preferences: An investor may prefer one asset class over another based on a certain bias or interest towards the characteristics of that class. For example, some investors avoid "sin stocks" like tobacco companies, alcohol manufacturers, or casinos.

Time Horizon: The length of time an investor is willing to commit to achieving his objectives.

Taxation: Investing in a mix of asset classes will have varying tax consequences.

An Evolving Strategy

Financial markets are constantly changing, and so too will your financial goals. Thus, a sound asset allocation strategy requires regular, periodic reviews.   Gains in some asset classes and losses in others may cause a portfolio to become unbalanced; rebalancing the portfolio can ensure each asset remains properly weighted.  Furthermore, asset allocation strategies tend to shift as investors move through life's stages. Younger investors with longer time horizons may be able to tolerate losses, while older investors in retirement may prefer to receive monthly income from their portfolio. 

Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification.

Learn more about asset allocation by contacting us today.