This week we will dive into the merits of asset allocation, the first of the three practices that align with the principles of faith, patience, and discipline that we discussed last week. Think of these practices as preventative medicine.
Asset allocation is dividing your portfolio amongst the main asset classes of equities (stocks), fixed income (bonds & equivalents), and cash. According to well-known studies by Brinson et al., more than 90 percent of the variability of a portfolio's performance over time is due to asset allocation. Brinson measures the relationship between the movement of a portfolio and the direction of the overall market.
Now let’s look at how you allocate your portfolio to those different asset classes or buckets. When you allocate percentages of your portfolio to these asset classes it is important for you and your advisor to make sure they align with your risk tolerance, short, medium, and long-term goals, time horizon, and overall perspective on the markets. The “right” allocation depends on each investor; there is no cookie-cutter, one-size-fits-all scenario. This is why being transparent and having a close and trusting relationship with your advisor is very important. The better we know you the better we know what to do for you.
To sum things up, asset allocation can help insulate your portfolio from risk by exposing it to multiple asset classes that work differently, potentially softening the blow of volatility. Your age, time horizon, risk tolerance, goals, and overall perspective will help determine the proper allocation for your long-term investment portfolio.
Tune in next week when we will talk about two more practices - diversification and rebalancing.
Until next time…
One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit, please share.