We've talked over the last three weeks about some of the things you can put your money in: stocks, bonds, and cash. Those are the big three. Next, we're going to discuss how (i.e. asset allocation).
Asset allocation is the breakdown or organization or specifications of how you invest your money. To keep things simple, we'll use round numbers in our examples, always investing $100,000.
There are a few things to consider when determining your asset allocation: your tolerance to risk, your investment objective, your time horizon, and your investor psychology.
Risk tolerance/investor psychology - how capable are you of handling the rollercoaster of the market? Another way to ask it is, how much can you stand to lose before you pull your money out? If you have $100,000 invested, is that $10,000, or a 10% pullback? Is it $20,000 or a 20% pullback? What about $50,000, or 50%? How you answer this question will help set your investor profile.
Investment objective - What will this money be used for? Are you saving for a down payment on a house? A boat? Retirement? The bigger the goal, the longer it will take to reach it. The longer it takes, the riskier you're able to be with your investment selections. Conversely, the shorter the goal, the more conservative you should be with your investments.
Time horizon - We touched on this one a bit in the last section, but how long until you need to touch this money? Are you investing for retirement and have a few decades until you need it? Or are you saving for a down payment and so you are hoping to use it in five years?
So let's run through a few different "hypothetical examples" and see what your typical investor's allocation will look like given their investor profile.
Investor 1 - 25 years old, investing for retirement, somewhat comfortable with risk. Using stocks/bonds/cash, a likely portfolio would look like this: 70/20/10.
Investor 2 - 50 years old, investing for retirement, very comfortable with risk. I would suggest the same as the 25-year-old, even though it seems like they would rather take on more risk. And here's why. People in their 50s tend to want to make up for lost time because they haven't saved as much as they would've liked to. This is a mistake because if the market corrects, they could be in even worse shape.
Investor 3 - 30 years old, saving for a down payment, comfortable with risk. I'd tell this investor to keep his money at his bank, and perhaps explore a high-interest savings account at an online-only bank. The return you'd possibly get investing for five years is not enough, in my opinion, to risk losing some of what you saved. You can end up having more saved than you planned or you could have to save for longer because the market dipped.
Asset allocation then, is how you organize your portfolio. Typically, it's used when talking about stocks, bonds, and cash, but could also be referenced when investing in precious metals and other investments that can be utilized inside of investment/retirement accounts.
Please let me know if you'd like some clarification or explanation on anything I've said here.
Have a great rest of your week and all the best!
Disclaimer: Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.