Asset allocation is a strategy that involves dividing your investment portfolio among different asset classes, such as stocks, bonds, cash, and real estate, to achieve a balance between risk and potential return.
The goal of asset allocation is to create a diversified portfolio that can help you reach your financial goals while managing risk appropriately.
In this post, I’ll discuss the steps required to create an asset allocation strategy that’s right for you.
Steps For Asset Allocation
Step 1 Define Your Goals
The first step of any asset allocation strategy is to define your financial goals. Do you need $20,000 in 3 years for a nonpayment on a house. Do you need $3,000 a month in income within 15 years?
Different goals may require different levels of risk and return. But in every situation, getting crystal clear on the amount and timeframe will help you make it happen.
Step 2 Assess Your Risk Tolerance
The next step is to evaluate your willingness and ability to take on risk. Consider factors like your age, financial stability, time horizon, and comfort level with market fluctuations.
A higher risk tolerance may lead to a more aggressive asset allocation with a higher proportion of stocks. Whereas a lower tolerance allows you to spread things out more and focus on well-rounded prospects.
Step 3 Understand The Different Types of Investments
This step often begins with familiarizing yourself with the main asset classes and their characteristics. This will give you a general sense of what proportion of your portfolio should be in which classes.
While each asset class has its own broad characteristics, there are subsections within each, and a few outliers. Knowing the unique risk and return profile of type of investment will help guide your allocation allotments.
Step 4 Determine Your Target Asset Allocation
Based on your financial goals and risk tolerance, decide on the ideal allocation of assets within your portfolio. For example, you might decide on a mix of 40% equities, 25% fixed-income, 10% real estate, 10% cash, and 15% other.
From there you might want to get more specific by breaking things down by the type of investment. For example your stock allocation might look something like the blow table.
Step 5 Diversify Within Each Investment Type
Aim for further diversification within each type of investment category. For stocks, consider different sectors and geographic regions. For bonds, consider various maturities and credit qualities.
Step 6 Monitor and Rebalance Your Portfolio
Over time, the performance of different assets will vary, causing your portfolio’s allocation to deviate from your target.
Review your portfolio regularly and rebalance it by buying or selling assets to bring it back in line with your desired allocation.
To Sum Things Up
If you follow the steps above, you’ll be able to create an ideal asset allocation strategy for your needs. You can increase your results by incorporating various investing principles.
Remember to avoid making emotional decisions based on short-term market fluctuations. Your asset allocation strategy should be followed until you decide that shifts need made to stay on track with your goals.
