What Is Asset Allocation?
Asset Allocation refers to the allocation of investment funds between different asset classes based on investment needs. Usually, assets are allocated between low-risk, low-yield securities, and high-risk, high-yield securities.
Why is Asset Allocation Important?
Asset allocation is one of the most important links in the investment process and a major factor in determining the relative performance of portfolios. According to relevant research, asset allocation contributes more than 90% to portfolio performance.
On the one hand, it is effective in semi-strong In the market environment. Information on investment objectives, profitability, scale, characteristics of investment varieties, and special time-varying factors all have an impact on investment returns. So asset allocation can play a role in reducing risks and increasing returns.
On the other hand, with the expansion of the investment field from a single asset to multiple asset types. And from the domestic market to the international market. It includes both the allocation between domestic and international assets and the handling of currency risks
To meet investment needs, the significance and role of asset allocation have gradually become apparent. That can help investors reduce the non-systematic risk of a single asset.
From the perspective of actual investment needs, the goal of asset allocation is to use the historical performance of asset classes and investors’ Based on risk appetite. Determine the proportion of different asset classes in the portfolio, And reduce investment risk and increase return on investment.
Asset Allocation by Age
There are many asset allocation strategies that can be used to shape your investment portfolio. Consider the most popular of them
Percentage of bonds equal to the number of your years
With age, the vast majority of people lose their desire to take risks, even if the risks promise high profits, and seek to ensure financial stability. Financial experts advise using the rule when forming a long-term investment portfolio: the percentage of bonds in your portfolio is equal to the number of years you have lived.
If you form your investments at the age of 20, then bonds, which serve as a kind of financial safety cushion, should be no more than one-fifth of the total invested amount. By the age of thirty, the shareholding will increase to a third of your investment, and by the 50th anniversary, it will be half the portfolio. Thus, you will come to retirement age, having reliable financial security.
120 minus age strategy
For those who prefer aggressive financial behavior and want to earn as much as possible on the stock market, the “120 minus age” formula will be successful, which determines the percentage of shares in your investment. Based on it, at the age of 20, you will not buy bonds at all, keeping all the amount available for stock transactions. At 35 years old, 15% of your assets will be stored in bonds, the rest will be used to purchase shares, etc.
This strategy assumes that the younger the investor, the easier it is for him to recover from financial losses, recover lost and receive a higher income from his investments. With age, the share of stable but low-yield bonds in your portfolio increases, which by the 70th anniversary will make up about half of the portfolio.
Loss Doubling Strategy
If you are not going to risk half or most of the assets, but are still interested in increasing the profitability of investments, we recommend using the principle of doubling the allowable losses. Determine for yourself what share of assets you are ready to part within the event of a market fall, and multiply it by two. This will be the share of high-risk shares in your investments. If the percentage of losses allowed for you does not exceed 10%, then the proportion of shares will be 10 × 2 = 20%
The size of the risk should correlate with income received outside the stock market. If your salary is high enough and stable, then risky operations in the stock market will not reduce current welfare too much in case of a wrong choice of stocks. On the other hand, too frequent losses should force a review of the chosen strategy towards a reduction in the percentage of risky investments.
Five steps to effective financial management
- Various factors affecting investors‘ risk tolerance and income demand. Including the age or investment cycle of investors, assets and liabilities, financial changes and trends, net wealth, risk appetite and other factors.
- The risk and return status of various assets and related capital market environmental factors. Including the international economic situation, domestic economic conditions and development trends, inflation, changes in interest rates, fluctuations in the economic cycle, and supervision.
- The problem of matching the liquidity characteristics of assets with the liquidity requirements of investors.
- Investment term. When investors choose between assets with different maturities (such as bonds ), they need to consider the arrangement of investment terms.
- Tax considerations. The tax result is of great significance to investment decisions. Because the performance of any investment strategy is evaluated by the amount of its after-tax income.
Asset allocation is your decision on how you divide your investment portfolio into different asset classes, such as stocks, bonds, and cash, to maximize the chances of achieving your financial goals with the least risk.
An asset allocation fund is a mutual fund that provides investors with a portfolio of fixed or variable combinations of the three main classes of assets — stocks, bonds, and their equivalents — in various securities. Some asset allocation funds retain a certain share of asset classes over time, while others change the proportional composition in response to changes in the economy and investment markets.