As the global markets continue to fluctuate, many investors and their portfolios are feeling the effects. Therefore, a sudden dip or rise in a portfolio may be the perfect time to take a look at whether or not one’s investments are truly diversified and assets are properly allocated among the different asset classes (e.g., equities, fixed income, and money market/cash equivalents). Asset allocation and diversification are techniques used to manage risk and attempt to balance the risks versus rewards of an investment portfolio. However, neither asset allocation nor diversification can prevent investment loss or assure a profit.
For many investors, investing typically begins with the purchase of a stock, a bond or a mutual fund. Over time, other investments may be added because many people understand it may not be prudent to invest in a single investment. However, simply “spreading money around” in various investment vehicles doesn’t necessarily create a properly diversified portfolio.
A sound portfolio management strategy begins with diversification – that is, dividing investments among major asset classes. Since each type of asset class has unique characteristics, they will rarely rise or fall at the same time, creating somewhat of a buffer in your investment portfolio. An investor can then make finer distinctions within each asset class by combining different assets to help soften the risks and losses within the portfolio, though in no way do they eliminate them all together.
The main objective of diversification is to match the characteristics of the various investments and their asset classes to percentages allocated within your investment portfolio so that the allocated percentages match the most important aspects of your personal investment profile. For example, your tolerance for risk of loss or ability to handle the ups and downs of a volatile market and what you ultimately seek to achieve through investing should all inform how you allocate your investment dollars to different asset classes.
Investing according to your risk tolerance helps to keep you from making rash decisions when it comes to your investment portfolio. One way to measure your risk comfort zone is to ask yourself how much of a loss in a one-year period you could withstand and still stay the course. Finding an appropriate match of your tolerance for risk against the different volatility levels of returns is the ultimate goal of asset allocation. For example, if the thought of potentially losing 10 percent of your portfolio’s value over the next year for the potential to gain 20 percent within the next five years makes you uncomfortable, you may want to consider a more conservatively allocated portfolio. The potential for higher returns usually involves taking a greater degree of risk.
Lastly, understanding how long you want to invest in order to meet your goals is important. In fact, it may be the thing that makes you choose one investment vehicle over another. Your personal time horizon extends from when you implement an investment strategy until you need to begin withdrawing money from an investment or investment portfolio.
You may wonder at this point how much should be invested in each asset class. The short answer is that asset allocation is more a personal process than a strategy based on a set formula. There are guidelines to help establish the general framework of a well-diversified and properly allocated portfolio but no two portfolios are alike. Keep in mind, a properly allocated and diversified portfolio will not guarantee against a loss and there is no guarantee that an allocated or diversified portfolio will outperform the market.
When crafting an asset allocation strategy, make sure to take all of your assets into account, including your retirement savings and any other investments you may. That way, you can ensure that all your assets are working together to help meet your goals and objectives throughout all stages of your life.
Prepared by MetLife
Delivered courtesy of Wayne Kuykendall, Financial Services Representative
Strategic Financial Partners, an office of MetLife
For more information on the financial, risk and wealth management strategies that Wayne Kuykendall provides, please contact him at 256-777-4524, firstname.lastname@example.org , or 105 South Marion Street, Suite 202, Athens, AL 35611.
By: Wayne Kuykendall, Financial Services Representative with
Strategic Financial Partners, an office of MetLife.