What is asset allocation?
Asset allocation refers to the way you weigh investments in your portfolio to try to meet a specific objective. For instance, if your goal is to pursue growth (and you’re willing to take on market risk in order to do so), you may decide to place 20% of your assets in bonds and 80% in stocks. The asset classes you choose, and how you weigh your investments in each, will probably depend on your investment time frame and how that matches with the risks and potential rewards of each asset class.
Selecting a mixture of different types of investments, and allocating a different percentage of your investable dollars toward them, is called asset allocation. Asset allocation is based upon the investment premise that “You shouldn t put all of your eggs in one basket.” Investment theory suggests that diversification, spreading your investment portfolio over more than one investment vehicle or asset class, may temper market fluctuations. The main investment asset classes are stocks and bonds. Each is generally assumed to possess a different level of risk. Risk addresses the variability of returns. Stocks are generally considered riskier than bonds, as the equity markets have historically proven more volatile—possessing wider ranges of positive upswings and negative downturns.* Most financial advisors also recommend allocating a portion of your assets to cash (usually six months of living expenses) in case of an emergency. Why Should You Consider Asset Allocation? It May Provide Divers
Asset allocation refers to the relative amounts of various assets that you own. For example Susan might own a house, a car, have a 401k with her employer and keeps some cash in the bank. What is her asset allocation? If her assets have the following values: • house – $200k • 401k – $40k • car – $10k • cash – $10k then their total assets is equal to $260,000. Normally you talk about asset allocation in terms of percentages of the total – so for our example Susan would have the following asset allocations: • house – 77% • 401k – 15% • car – 4% • cash – 4% From these numbers it is clear that this person has a high weighting of real estate at 77% (their house) and a low weighting of cash (only 4%). An important term to learn is asset classes – these are assets that are similar enough that you would group them together when talking about asset allocation. For example if you own two different stock mutual funds then you might just lump them together in your “stock” allocation.
