The Benefits of Disciplined Portfolio Asset Allocation and Diversification
Asset allocation involves dividing your investment portfolio among different asset classes, such as stocks, bonds, and cash, as well as across different geographic regions and market capitalizations (i.e., company sizes). Determining the most appropriate mix for a pool of assets comes down to balancing risks relative to the potential return.
- One primary consideration in developing an appropriate asset allocation is identifying future cash needs from your investment portfolio. This ties directly into the critical factor of time horizon. Your ability to maximize your rate of return while not taking too much risk will go a long way toward building your retirement nest egg.
- An additional important consideration is how comfortable you are taking risks. Investments can lose value, and the risk of loss is directly tied to their potential to earn outsized returns. So, you’ll need to decide how much risk you’re willing to take. Generally speaking, the more time you have to let assets grow, the more risk you can take. However, this is still a very personal decision, and one you should weigh carefully.
- If you’re a risk‑averse investor, that means you prefer to preserve principal over the potential of a higher rate of return. At the same time, risk‑seeking investors prefer the potential of higher returns despite the possibility of losing their principal investment.
The most important portfolio investment decision you can make is to determine the asset allocation that best matches your time horizon, risk tolerance, and required rate of return. As time passes, you should also reassess your allocation structure to make sure it remains consistent with your needs and time horizon.
Historically, the returns of the three major asset categories have not moved up and down at the same time.
By investing in more than one asset category, you can reduce your risk of losing money in a declining stock market and the volatility of your portfolio’s overall investment returns. For example, if stock returns decline, an allocation to bonds would likely counteract your losses.
A diversified portfolio is your best protection from a market pullback, but your ability to select the appropriate asset allocation alone will not truly diversify your portfolio.
Diversification is achieved by spreading your investments across geographies, sectors, and market capitalizations, as segments within each asset category will perform differently under different market conditions.
At Plimoth Investment Advisors, we use a conservative, disciplined approach that allows you to enjoy customized investment management solutions. Please contact me to learn more about asset allocation and portfolio diversification today.