What Does Asset Allocation Mean?
If you are new to the world of investing, one can easily get lost and overwhelmed with all the jargon surrounding it. The world of stocks, bonds and other investment vehicles are complicated enough even to the seasoned investor, moreover to someone who has just forayed into it. So before you head off to the bank or talk with a potential portfolio manager, it is best to arm yourself first with a basic knowledge.
Investing is all about proper asset management. The novice investor is familiar with some of the different kinds of assets, or anything that holds value. An aspiring investor should have a working knowledge of stocks, bonds, certificate of deposits, mutual funds and the like. Other asset categories including real properties and commodities can also be included in your investment portfolio.
Your portfolio would then need to be managed, balanced in a way that would optimize an investor’s desired results. For shares, bonds and similar instruments, this is called investment management. And now we come to an investment management strategy that you, as an investor, would have a say on – asset allocation.
What is asset allocation?
Asset allocation answers the question of where you will invest your money in and by how much. As an investor, this is one of the most important things you have to consider. Asset allocation is all about diversification based on your needs as an investor. As the great Warren Buffet said, “Don’t put your eggs in one basket”.
Maximize your profits and minimize your risk by spreading across multiple investment vehicles to cushion any adverse impact of any economic conditions. If something goes wrong with one of your holdings, for example company A, you don’t lose as much as if you only had that company in your portfolio.
So how do you allocate your assets? Simply put, there are 3 factors that come to play:
- Your investment goals – This is your reason for investing and how much you are expecting to earn. For example, an individual planning for retirement. Or a small company wanting to invest liquid assets in the short run.
- Your risk tolerance – This is how much risk you are willing to take. Are you an aggressive risk-taker who wants higher returns but doesn’t mind the ups and downs of the stock market? Or are you the conservative type that wants stable returns over a period of time? Your portfolio manager will ask you relevant questions that will help them decide how to divide your assets based on the category of how much you will earn back and the related risk for each, mainly: equities, fixed-income, and cash & equivalents. Each has certain behaviors over a period of time.
- Your timetable, what you call your investment horizon – This is how long you intend to keep your portfolio. It can be short-term or long-term. From as short as a few days to a period covering decades.
To illustrate, a single 30-year-old professional who doesn’t mind taking risks in the stock market and is looking into saving up for retirement, might consider a portfolio of 70% equities and 30% fixed income. This would mean that since one is not in a rush to see the income returned, they don’t worry so much about the short-term risks or market fluctuations. And as one nears the retirement age, the mix would gradually be on the safe side as one would not want to risk losing the yields earned over the years. That means one would shift to more fixed income and reduce high risk equities.
In contrast, someone who is just saving up for a dream house in the near future might just want somewhere where they can keep extra cash which yields returns higher than the regular savings account. They would then invest more in stable, short term fixed-income instruments like bonds or cash equivalents.
All of these points will help you decide the right mix for you. But it doesn’t stop there. Your portfolio needs to be monitored and re-balanced from time to time to ensure that it still reflects your desired outcome. In the end, your portfolio should pretty much reflect not only your desired revenue and risk appetite, but also your needs. That is why you need a reputable investment management company in Seoul, Korea that will help you achieve optimal asset allocation.
Read more in our article: Wealth Management and Its Importance