I was speaking with a prospective client last week about our investment process, and she asked what Asset Allocation was.
If you don?t know the answer to that question, your current advisor is doing you a disservice. For those of you not familiar with Asset Allocation, here is the answer:
Asset Allocation is both an investment philosophy and an investing discipline. It combines the idea of diversification with a defined strategy. An asset allocation should be customized and tailored to each individual investor based upon their individual risk tolerance, goals, and timeframe to meet those goals. There are many questionnaires available to help you determine your investor profile.
The practice of Asset Allocation is based upon numerous research studies, most notably that of William Sharpe and Harry Markowitz. They won the Nobel Prize for economic sciences, for their contributions to the science of portfolio management. Their studies suggest that a well diversified Asset Allocation plan may effectively reduce risk while maintaining or possibly even increasing the portfolios rate of return. More importantly, asset allocation has been shown to be responsible for up to 91.5% of a portfolio’s performance.
For more information, take a look at the Importance of Asset Allocation .
The goal is to invest your money in a variety of asset classes, in amounts determined by your specific, customized investor profile. An asset allocation plan should be tailored to meet your needs as determined by your risk tolerance, your goals and the timeframe for meeting those goals.
For example, here are some of the different asset classes:
- Large Cap US Stocks
- Small Cap US Stocks
- International Stocks
- Corporate Bonds
- Government Bonds
- Alternative Investments
Take a look at this Callan Chart and you will see that every year (give or take) a different asset class is the top performing asset class. By subscribing to this theory, you may be more likely to have at least a portion of your money invested in a top performing asset class, year after year.
This is a simple overview of Asset allocation. Asset allocation can be combined with other investing strategies such as dollar cost averaging or annual rebalancing. Asset allocation does not assure a profit or protect against a loss in declining markets.
