Understanding Asset Allocation

Understanding Asset Allocation

by Caitlin Combest on Jul 31, 2017

Asset allocation is an investment strategy that aims to balance risk and reward by dividing a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk. The investment portfolio is divided into cash, stocks, and bonds and each has a different level of risk and return attached. While many of you will chose to invest, it is important to know that all investments come with risk. Dipping into some risk means knowing you could lose a portion of your money, but doing it because you also know there is an opportunity for reward. The reward for taking on risk is the potential for a greater investment return. In a way this is very similar to any and every other risk you’ve made, whether it be trying out a new recipe or something as thrill seeking as sky diving.

Asset allocation plays a major role in determining whether or not you will meet your financial goal. Because we all have different financial goals and comfort levels, asset allocation looks different in every investment portfolio. For instance, there are several options for investments, including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds, money market funds, and U.S. Treasury securities. As mentioned in the paragraph above, an investment portfolio is divided into cash, stocks, and bonds. These three are the most common in the asset category and are commonly used in retirement and college saving plans. As all investors have specific objectives, there are different asset allocations. Someone preparing to buy a large item might look to cash, certificates of deposit (CDs) and short-term bonds. Another individual saving for retirement may invest their individual retirement account (IRA) in stocks.

If you understand your time horizon, risk tolerance, and have some investing experience you may feel comfortable creating your own asset allocation model. However, you need to carefully select a model that is right for you and in line with your financial goals. Your finical advisor can assist you with this and with time you will become more knowledgeable on the topic of asset allocation.