The Importance of Asset Allocation

Asset allocation is an investment strategy that involves spreading your investment across different asset categories such as stocks, bonds, cash, or alternative categories, as a means of reducing investment risk.

Asset allocation protects investors from significant losses. The principle behind this strategy is that the different asset categories have little, or in some cases, negative correlation. This means that different types of assets perform differently under different market and economic conditions. For example, if your investment portfolio consists of stocks, bonds, and cash, when your stock investment is doing poorly, the same market or economic condition that caused stocks to fall, will favor bond returns. That way, you can protect yourself from significant losses, while maximizing on your returns.

What categories should you include in your portfolio?

There's no one formula that determines which asset category is the answer for every investor. The decision can be influenced by factors such as the level of risk tolerance and time horizon.

Risk Tolerance

This refers to the level of an investor's willingness to lose some, or all, of their money to gain greater returns. Riskier asset categories have the highest possible returns, so daring investors are likely to go this route, and have a higher percentage of stock investments in their portfolio, while those with low-risk tolerance are more comfortable going for less risky asset categories.

Time Horizon

This is the number of months or years an investor needs to keep investing in order to be able to reach a particular financial goal. An investor with a long-term goal, like saving for retirement, may be confident in investing more in riskier and more volatile options. In contrast, you may need to take a less risky option if you're saving for your child’s college education.

Here’s the bottom line: all investment types have associated risks. Asset allocation can help protect you from significant losses while maximizing returns, which is a win-win in the world of investment.