When you invest, your money goes into different assets. These are government bonds, mutual funds, stocks, retirement savings, and even real estate.
Not all of these assets carry the same risk. For instance, stocks are deemed riskier than say government bonds. Choosing your ideal mix of assets will depend on various factors including:
Your age: Your allocation strategies shouldn’t be the same in your twenties as in your fifties. That’s because the risk needs to start reducing towards the end of your investment journey so you can start preserving more of your capital. Your risk appetite: The mixture of asset classes will depend on whether you’re a conservative investor or not. Those who are willing to take on more risk, might include assets such as cryptocurrency in the mix, or have a higher percentage invested in stocks. Your goals: If you’re saving for a gadget you want to buy in a few weeks or months, it doesn’t make sense to put that money into a volatile, high-risk stock. Sure, it might pay off and you’ll have a quick return, but that’s not the norm. Short-term investing should be in a low-risk, even no-risk portfolio. Retirement is different, however, as investors often start in their twenties or thirties with the hopes of retiring in their late fifties to early sixties. This gives enough time to catch up with the many market downturns synonymous with investing.
Why do we recommend strategic asset allocation?
Strategic allocation allows you to be intentional about your investment choices, without being chained to the mundane of everyday management. Sure, you might have to spend some time on it, but make it a once-a-year thing if you can.
So how do you do this? Automated investments. You can automate everything from the money that goes from your bank account into the fund, to choosing funds and assets. You can even put a mandate in place for fund switches when there’s a serious market nosedive.
How to set up strategic asset allocation
First, let’s start with an example:
Imagine you’re a 24-year-old who just opened up a brokerage account with $3,000. If you want to employ strategic asset allocation, you’ll want to set certain percentages you’ll want in each asset class based on your goals.
Since you’re young and have many years before retirement, you might be more willing to take risks with your portfolio. Considering this, you decide to be aggressive and put your money in 80% stocks ($2,400) and 20% bonds ($600).
A year later, you discover that your stocks accrued 20% from your initial investment, while your bonds have earned you just 2%. This leaves your assets at 82% stocks ($2,880) and 18% bonds ($612).
Now your assets are “unbalanced” in accordance with the goals you set for them and it’s time to rebalance them.
In order to stay in line with your strategic asset allocation strategy, you’ll need to take 2% or about $57.60 out of your stocks and into your bonds. That’ll leave your portfolio nice and balanced at 80% stock and 20% bonds once more.
Of course, your goals will change over time. As you get older, you’ll find that you might want to be more conservative with your investments, and you can change your asset allocation percentage so they fit your needs.
Consider the following scenarios, including your timeline and risk tolerance to help you figure out the best asset allocation strategy for you.
Determine your investment timeline
Your asset allocation should be adjusted according to the amount of time you have to invest. For instance, if you have a one-year goal or a fifteen-year goal, the investment strategies should look different. The shorter the term, the less risk you should have in your portfolio. Ideally, investments should run for a minimum of ten years to get the most out of the markets.
Assess your risk tolerance
Risk tolerance is how much risk you want to expose your capital to. An aggressive approach might not be for everyone, even if they have 20 years plus to ride out the markets.
It’s important that you are comfortable with your risk tolerance because there is always an opportunity for loss in investing. The higher the risk, the higher the chance of loss. But there’s also a chance of higher earnings. The point is, you need to be comfortable with the potential of your risk class compared to the potential for total loss.
Determine your goals
What is the point of investing and how will strategic asset allocation play into those goals? If your goals are to spend as little time micro-managing your investments as possible, then strategic allocation is your best investment friend. Add to that investment automation and you’ll have plenty of free time to do whatever you want instead of scouring newspapers, widgets, and indicators for hours a week trying to maximize your returns.
Sure, there is a time to intervene but knowing when and how often is what will allow you to strike a good balance.
You want to spend less time figuring out financial jargon You prefer investment automation Risk tolerance is worked into your allocations There’s a planned review every year to determine whether you’re still on the right course and whether your allocations are where they need to be
Purchase funds in each asset class
This is a simple way to make sure you have a nice, diverse investment portfolio. And diversity matters. Remember when financial pundits were telling everyone that property was the safest portfolio and that the likelihood of a market crash was just, well silly?
Turns out that did happen and well, we literally refer to it as the mortgage crash. Now, property is still worth looking at when considering your investment strategy because the market did quite a rebound. But here’s the thing. Don’t tie all your money up in that one asset that seems to be going well at that point in time. Those who were able to wait it out managed to make their money back and then some. Those who retired at the time of the crash, not so much.
Split your assets as much as possible to increase your chances of good returns and reduce your risk. Even when you’re investing in an asset, for instance, stocks, split those funds even more. Consider index funds that include a basket of funds so you’re as diverse as you can possibly get.
Rebalance your portfolio every 12-18 months
In order to stay balanced, you’ll need to check out your portfolio and rearrange funds in order to stay in accordance with the allocation percentages you set as a goal.
Strategic asset allocation vs tactical asset allocation
Now, it’s worth mentioning that these asset allocation strategies don’t exist in isolation. Also, strategic asset allocation is just one method of dealing with your investments. There’s also no rule that says if you choose one method, you need to stick to it for the next thirty or forty years.
It’s not unusual for you to use several methods at times, even if you have a main method. For instance, you can opt for strategic allocation, and at times, employ tactical allocation.
Tactical allocation simply means you’re in the thick of it all the time, making even the minutest decision regarding your investments. It’s the opposite of the hands-off strategic allocation model.
Fund managers often use a tactical approach to asset allocation and it works, because they know what they’re doing. The goal here is to maximize profits and when this is done, the portfolio is returned back to its original state. It’s only supposed to be a temporary measure.
There are other allocation methods too.
Constant Weighting Asset Allocation: You allocate certain percentages to certain asset classes, for instance, 80% to stocks and 20% to bonds. When the markets shift and you’re suddenly 25% in bonds, you immediately adjust this. Some investors allow the balance to tilt by up to 5% before they adjust their investment split. Dynamic Asset Allocation: You’re in a constant game of buy and sell. When markets are weak, you sell and when they pick up, you buy. This method plays into the strengths of portfolio managers. Insured Asset Allocation: This method allows you to establish a base profit margin and should the investment dip below it, you start moving funds to secure investment assets that carry little to no risk. Integrated Asset Allocation: This method is entirely focused on risk and may include aspects of the other methods. Assets are chosen with the investor’s risk tolerance in mind and all decisions regarding investments are weighed up against risk, not possible future returns.
Investing can be as easy or as hard as you want it to be but when your portfolio strategy is all about asset allocation, you’re one step closer to a healthy asset mix. But if you really want to know all the ins and outs of investing, saving, and more, you should check out our Ultimate Guide to Personal Finance.
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