A Deeper Look Series: Asset Allocation

Welcome to A Deeper Look series. One of the ways of understanding finance is understanding many of the terms you are not used to hearing every day. These terms may sometimes be confusing, so it helps to get some background and perspective.

Today, I would like to share the term “asset allocation.” Asset allocation is an investment strategy that incorporates the risk tolerance and investment time horizon of the investor. It may sound simple, but there are many ways to allocate assets within an investment portfolio. Most approaches consider three main sets of asset classes: equities, fixed-income and cash or cash equivalents.  Each class has a different level of risk and expected return, and each will generally perform differently than the other. There are additional classes such as “alternatives,” real estate and precious metals that can also be considered as part of an allocation.

Diversification Explained

Allocating assets among various asset classes provides diversification. The saying “Don’t put all your eggs in one basket” is a good metaphor for diversification. By allocating among different assets that perform differently under varying market conditions, you may avoid some of the impact of adverse conditions across your entire portfolio. Equities and fixed-income (bonds) typically move in opposite directions, and different types of equities may also not move in the same ways. Equities as a rule will have more risk of ups and downs as opposed to fixed-income investments. In the same way, equities may provide a higher reward in an “up” market than bonds, which don’t typically move in large swings. Each type of investment carries its own types of risk as well, so an investor should be fully aware of what they are investing in to consider the risks and rewards associated with each.

How Should You Allocate?

Many factors influence how an investor should approach their asset allocation. Portfolios to be allocated should be planned for long term investment savings. A person in their 20’s and 30’s may be investing for 35 or more years. The portfolio may include a higher percentage of higher-risk equity investments, whereas someone with only five years to retirement would take an opposite approach with more fixed-income and principal-protected investments. There may be factors, however, that will affect both of these scenarios.

One of the best ways to determine your financial needs is to talk with a trusted financial advisor about your short- and long-term goals and your risk tolerance.  

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. You can reach us by clicking here.

“Finance Made Simple” blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.

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