All About Asset Classes – Asset Allocation
We all want to get the most out of our investments. One of the best ways to do so is with asset allocation. You may have heard this term tossed around before, but what is asset allocation, how does it work and are all strategies the same? We’ll take you through all you need to know to get the most out of your portfolio.
Asset allocation defined
Asset allocation is the selection or mix of investments across different asset classes. These could include equities (such as stocks), fixed-income instruments (bonds), cash or alternative investments (real estate or commodities).
At its fundamental, asset allocation is about selecting the right type or combination of investments for your portfolio to keep your financial plan on track—providing enough return to reach your goals and a level of risk you can stomach without changing your savings habits or investment strategy. While an important part of investing, asset allocation can be complex and time consuming, which is why many investors turn to professional managers or advisors for guidance.
The importance of diversification
The main benefit of asset allocation is that it spreads your money across different asset types to give you diversification. When your portfolio is diversified, its helps protect your investments from dips or swings in a single part of the market, while still providing exposure to the growth or returns in others.
For example, say your portfolio has a mix of equities, cash, and real estate. One day, stock markets take a turn and your equity holdings drop in value. While that portion of your portfolio may see negative returns, you’ve still got money invested in cash and real estate to keep your overall portfolio out of the red.
Finding the right asset allocation
To find the right asset allocation or “mix” for your portfolio, ask yourself four questions:
- What is your financial goal (what are you saving for)?
- What is your time horizon?
- What is your risk tolerance?
- What is your risk capacity?
If you’ve just started working and want to begin saving for retirement, you likely have a longer investment time horizon. This means you may be okay putting more weight on riskier asset classes like equities or alternative investments. But if you’re saving for a house a few years down the line, with less time to make up any losses, fixed income or cash might be better suited to safeguard that down payment.
The key, whatever your goal, is to maintain the right mix (diversification) so you can maximize returns at whatever risk level you’re comfortable with and able to afford.
Tactical vs. strategic asset allocation
Once you’ve established your goal, time horizon, risk tolerance and risk capacity, it’s time to put that asset allocation to work. But there’s a couple different ways to go about this, namely: strategic asset allocation and tactical asset allocation.
Strategic asset allocation
Strategic asset allocation takes a long-term approach to setting your asset mix. It encompasses factors such as the historical performance of the asset class, long-term market risks and opportunities, among others. Targets are set for how much to allocate to each asset class in the portfolio to help ensure investors meet their financial goals within their time horizon and desired level of risk. For example, a more aggressive portfolio may see 50% allocated to equities and 20% to alternative investments, with the remaining 30% to fixed income or cash.
The portfolio will typically be rebalanced periodically (i.e. quarterly or annually) to keep the asset class weightings in line with the strategies or targets. So, taking the previous example, if the equity portion grows to 55% of the overall portfolio, 5% will be switched into fixed income to bring the mix back to 50% and 30%, respectively.
Tactical asset allocation
Tactical asset allocation still takes into consideration the long-term strategic approach, but gives the flexibility for small “tactical” adjustments based on short-term economic or market conditions. A tactical shift could be made in the portfolio to deviate slightly from the original asset mix in order to take advantage of opportunities in the market, reduce risk and, ultimately, create extra value for investors.
Incorporating asset allocation in your portfolio
Want to incorporate asset allocation into your portfolio? At CI Direct Investing, we take the view that your asset mix is the primary driver of portfolio performance. That’s why we follow an investment strategy that aims to do just that—invest our clients’ money across a diverse set of asset classes to maximize returns at specified levels of risk.
Even better, you can access our asset allocation strategies through a variety of portfolios tailored to your needs and preferences, from low-cost ETF portfolios, to portfolios with exposure to private investments, socially responsible impact investing portfolios and more.