Your asset allocation aims to divide your investments into different asset classes (usually stocks, bonds and cash) to balance your level of risk and return. The idea behind asset allocation is simple – reduce your risk exposure through diversification, or “don’t have all your eggs in one basket”. But as simple as it may sound, your asset allocation plays one of the most important roles in helping you achieve your financial goals.
Why is it so important?
According to Vanguard, a diversified portfolio is responsible for 88% of your experience (i.e. your risk exposure vs. your returns) . To put it differently, your experience will be consistent with that of other investors with similar investment portfolios, regardless of how they have invested their funds within a specific asset class (if they have picked stocks different to yours, for example). This goes to show that your asset allocation is far more important in determining your returns when compared with the performance of any individual asset class.
Your asset allocation also plays a vital role in ensuring the consistency of your returns. This is because the market conditions that cause a certain asset class to perform well could also be the same ones that result in other asset classes underperforming. A well-designed portfolio will guard against these downsides and ensure consistency in returns – which is especially important if you are a retiree that is solely dependent on the returns of your asset base.
In addition to these, your asset allocation also plays a pivotal role in ensuring that you achieve your financial goals. An investor that has too much exposure to conservative asset classes such as cash will find themselves generating far fewer returns than what is required to achieve their goals. On the flipside, investors that have invested too aggressively may find that they do not have enough money when they need to access it. This is why selecting the asset allocation that suits your individual circumstance is so important.
A well-designed portfolio will ensure that you are generating consistent returns and will help you work towards your financial goals. You will also have the peace of mind knowing that you have taken measures to safeguard against any potential upsets in the future. Lastly, keep in mind that your asset allocation is not a one-off exercise! It is a continuous process of fine-tuning and refinement. Over time, your portfolio will shift away from its original allocation, and will need to be rebalanced or readjusted to reflect your position at the time.
If you haven’t yet invested the time in your asset allocation, reassessing your existing portfolio can be a good place to start. If working on your ideal portfolio seems like a daunting task, it might be a good idea to work with an experienced financial planner as he/she will be able to guide you on the best way forward.
 Asset allocation: Key to your investment climate, Vanguard, Accessed November 2020: https://investor.vanguard.com/investing/how-to-invest/asset-allocation