Asset allocation refers to the process of distributing investments across different asset classes such as stocks, bonds, cash, real estate, and commodities, based on an investor's financial goals, risk tolerance, and time horizon. It is a strategic approach to diversifying and managing investment portfolios.
The main objective of asset allocation is to optimise the risk-return profile of a portfolio by spreading investments across different types of assets. The rationale behind this strategy is that different asset classes tend to perform differently under various market conditions. By allocating investments across multiple asset classes, investors aim to reduce the overall volatility and potential risk of their portfolio while maximizing potential returns.
Asset allocation is typically determined by assessing an investor's risk tolerance and investment goals. Risk tolerance refers to an individual's ability and willingness to endure fluctuations in the value of their investments. It can be influenced by factors such as financial situation, time horizon, investment knowledge, and personal preferences.
The specific asset allocation mix will vary based on an investor's unique circumstances, but it generally involves diversifying investments across multiple asset classes, such as stocks, bonds, and cash equivalents. The allocation can be further refined by considering subcategories within each asset class. For example, within the stock portion, an investor may allocate funds to different industries or geographic regions.
Asset allocation is not a one-time decision; it requires periodic review and rebalancing to maintain the desired allocation. As market conditions change and investments perform differently, the asset allocation may deviate from the original target. Rebalancing involves selling or buying assets to bring the portfolio back to the desired allocation.
It's worth noting that asset allocation does not guarantee profits or protect against losses, and its effectiveness may vary depending on market conditions. Therefore, it is important for investors to regularly assess their financial situation, monitor their investment portfolio, and consult with a financial advisor when making asset allocation decisions.
Given how important asset allocation is for an investor's portfolio, we've built a number of tools to allow users to mange their asset allocation, and rebalance where necessary. This starts with the Portfolio Breakdown tool, and finishes with bespoke financial advice.