The Asset Allocation Decision

One of the first decisions to be made in structuring your investment portfolio is what its asset allocation should be. You need to decide on the types of securities in which you should invest and the percentage of your investment funds to invest in each.  Note that this doesn’t refer to the choice of specific securities, but rather to broad categories.  How much of your money should be invested in stocks? How much in bonds? How much in a bank savings account and/or similar assets?  And within these categories, you will need to decide what percentage, if any, of your monies you want to invest in domestic stocks, foreign stocks, government bonds, corporate bonds, large companies, and small companies.

There are a number of things to take into consideration when making these decisions.  At the top of the list is your risk and return objective since your asset allocation will be the major determinant of the return you can expect to earn and the level of risk you will be facing.  Of course, we all want to shoot for the greatest possible return we can get, but we also all have different levels of risk aversion that must be recognized.  Some people enjoy spending hours on end in a casino; others become physically ill at the thought of losing even a dollar.  This is an important factor.  You want to be able to sleep at night.

Regardless of the level of your personal risk aversion, you also need to consider your investment horizon.  The shorter your investment horizon, the less risk you can afford to take because if the market has a downturn, you don’t have the time to wait for an upswing before you will need the money.  So, even if your favorite pastime is hunting crocodiles, if you expect to need the money in five or ten years, you should have more invested in bonds than in stocks.  A general assumption is that  a younger person can afford to take on more risk than an older person.

All else equal, equities can be riskier than bonds, and the stocks of small companies can be riskier than those of large companies.  Corporate bonds can be riskier than government bonds, but not all corporate bonds and government bonds are created equal.  Your need for immediate access to cash will affect the amount you invest in a bank savings account or similar liquid asset.  These investments are, of course, the safest, but they also have the lowest expected returns.

Our team can work with you to determine the asset allocation that will best fit your needs given your return objective, your risk tolerance level, and any other considerations that may apply to your specific case.  The asset allocation decision is not “one size fits all.”  Once this important decision is made, we can also help you to select the specific assets in which to invest your funds.