Definition: Asset allocation is a fundamental concept in financial planning and fine investment art. In simple terms, asset allocation guides your investment strategy by systematically investing assets in a diversified portfolio intended to generate the highest possible returns with the least amount of risk.
Asset allocation is considered when selecting an investment option because it helps investors achieve desired returns regardless of available time or money resources. Throughout the past decade, asset allocation has been one of the most popular investment strategies used by investors due to its simplicity, direct investment in equity securities, low transaction costs, transparency regarding investment decisions, and abundant, low-cost alternatives.
The most important asset class to own is equities, followed by fixed income and cash and equivalents. Equities might include stocks, real estate, private equity, commodities, and bonds. Fixed income includes interest, dividends, loan payments, and taxes. Cash equivalents include things like checking cash at your broker’s office and buying financial instruments such as stocks and bonds. Each class has its strengths and weaknesses, so you need to think about how much of each you should be spending, where you are putting your money, and how much you should save.
Asset allocation is a used for managing your money using asset classes rather than spending it all at once. Asset allocation is an essential part of any investment plan as it allows you to weigh up different risks and rewards. Knowing your risk tolerance will enable you to manage your cash and equivalents to match your other financial commitments. Investing in a range of asset classes, you can access different investment opportunities – without getting soaked by one type of risk or another.
Age-based asset allocation is more adaptive to market and industry changes and timeless; it adapts more quickly to changes in wealth and investment needs. As you become more experienced, you may wish to shift some assets to age-based asset allocation to ensure your long-term wealth is secure — even in the face of recessions and other market crashes. The age-based asset allocation determines which assets are targeted for investment. The government prefers to invest in assets that are long-term lose leaders while pursuing shorter-term gains by investing in growth assets. Growth assets include stocks, real estate, private equity, technology, and other innovation-based assets. The goal is to target these assets at careers with high potential for future growth even if earnings exceed expectations.
Asset allocation funds are a type of mutual fund that allows investors to prioritize asset classes based on their expected life cycle. This is intended to help investors meet their investment objectives, including ensuring adequate allocation over time for retirement goals, ensuring liquidity at retirement, ensuring growth in income over time, etc. Investors most commonly use an asset allocation fund within a family or other investing circle who share the same investment objectives but may not all be able to meet them simultaneously.
Asset allocation is an ongoing process that you can start today and continue throughout your career. Whether you are an experienced investor or just starting, you can allocate assets in a way that protects your capital while encouraging growth and returns in the years ahead.