Asset allocation

Proper asset allocation can help you achieve steady growth while protecting your portfolio from significant downturns. By ensuring your investments align with your goals, time horizon and risk tolerance, asset allocation plays a vital role in creating long-term financial stability and growth. But what does it really mean, and how can you ensure that your portfolio is appropriately balanced?

What is asset allocation?
Asset allocation refers to the process of diversifying your investments across various asset classes, such as equities (stocks), bonds, property and cash. Think of it as assembling a comprehensive toolkit, with each tool serving a distinct purpose. The goal is to achieve an optimal balance between risk and return, tailored to your financial objectives, risk tolerance and investment horizon. Each asset type responds differently to changing economic conditions.

For example, shares generally provide higher potential returns, which can be appealing for long-term growth. However, they come with significant volatility, meaning their value can fluctuate dramatically. Bonds, on the other hand, offer greater predictability and stability, although their returns are typically lower. Property can yield steady rental income and capital appreciation, but it also presents challenges, such as illiquidity (the difficulty of selling quickly).

Lastly, cash is the safest option for capital preservation, but it usually yields low returns, especially during times of high inflation. By diversifying your investments across these types, you minimise the risk of a single poorly performing area dragging down the overall value of your portfolio.

Why does asset allocation matter?
The importance of asset allocation cannot be overstated; it serves as the foundation of your financial plan. When markets fluctuate, as they inevitably do, a well-balanced portfolio ensures that your investments are not overly concentrated. Instead, you distribute risk evenly, which increases the likelihood of stable, long-term returns.

Consider this real-world example, if your portfolio in 2008 was heavily weighted toward equities during the global financial crisis, you might have experienced substantial losses as markets declined. However, if your allocation included government bonds or cash, those assets likely weathered the downturn better, mitigating some of the overall damage to your portfolio.

While past performance does not guarantee future growth, asset allocation has historically been a crucial factor in long-term investment performance, greatly exceeding the effects of decisions about which specific stocks or funds to purchase. The overall mix is what matters, not just the individual selections.

How to determine the right mix for your portfolio
Finding the right asset allocation begins with understanding your financial objectives. Are you investing to grow your retirement fund, save for your child’s university expenses or achieve financial independence by a certain age? Clearly defining these goals will help to shape your investment strategy.

Risk tolerance plays a crucial role as well. Consider this scenario: if your investments were to lose 20% in a single year, would you panic and sell, or would you hold steady, understanding that markets generally recover over time? Your response offers a clear indication of how much risk you’re comfortable accepting.

If the prospect of significant losses troubles you at night, a portfolio focused on bonds and cash may be a wiser choice. Conversely, if you’re comfortable enduring some volatility for potentially greater rewards, a larger allocation to equities could be appropriate.

Considering time horizons and rebalancing
Your time horizon – the period during which you intend to keep your money invested – greatly influences asset allocation. Longer time horizons allow for riskier, high-growth investments such as stocks. For instance, a 30-year-old saving for retirement might allocate 80% to equities and 20% to bonds. Conversely, shorter horizons, like saving for a house deposit in five years, necessitate conservative options such as bonds or cash that preserve capital.

Rebalancing your portfolio is as crucial as selecting the appropriate allocation from the start. Over time, your investments’ value will fluctuate, and some asset classes may appreciate faster than others. A previously well-balanced portfolio could become tilted towards equities if they perform exceptionally well.

Regularly reviewing and adjusting your asset allocation helps maintain the intended balance and keeps your strategy aligned with your goals and risk tolerance. For example, if equities originally made up 60% of your portfolio but increased to 70% due to strong performance, you may sell some equities and reinvest in bonds or cash to realign the mix.

Seeking professional advice
While many people feel confident managing their finances, asset allocation can be a complex area to navigate effectively. We offer invaluable support by assessing your situation as a whole, identifying overlooked opportunities, and guiding you through market uncertainties. We will also adjust your portfolio as your life circumstances or market conditions evolve.

Understanding and implementing asset allocation is a crucial step toward achieving your financial goals, but it doesn’t stop there. Maintaining a healthy portfolio requires regular monitoring, re-evaluating your goals and making necessary adjustments.

THIS ARTICLE DOES NOT CONSTITUTE TAX, LEGAL OR FINANCIAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE. THE VALUE OF YOUR INVESTMENTS CAN GO DOWN AS WELL AS UP, AND YOU MAY GET BACK LESS THAN YOU INVESTED.