Spreading The Risk: Asset Allocation

This is a sponsored post.

Above almost anything, the key to investing success lies in choosing the right investments and maintaining balance in your portfolio.

This is why creating an optimal asset allocation blend based on a balance of your risk tolerance and need for growth is crucial.

Over 90 percent of a portfolio's return variability is due to asset allocation – more than market timing and security selection.

While there’s disagreement among academics over exactly how much impact asset allocation has on performance, moving to an asset allocation-based passive investment strategy may optimize your own portfolio, and make the difference between retiring on a shoestring budget or a lifestyle of champagne dreams and caviar wishes.

What Is Asset Allocation?

To help visualize what asset allocation actually means, it’s helpful to use an analogy. 

Imagine a soccer team.  To build a great soccer team, you need defensive and offensive positions.  Having strong players in both areas is critical to accomplishing the team’s objective – to win.

In investing, the offensive and defensive players are like asset classes. Asset classes are types of investments that exhibit similar levels of risk and return, such as equities, fixed income, and real assets. As on a soccer team, you need a variety of asset classes: some that are offensive – which do well when the economy is charging ahead – and are defensive – that do well when the economy is falling behind.

Mixing asset classes is important because asset classes have shown different behavior in different market conditions. Balancing asset classes helps to decrease portfolio risk without losing returns.  A portfolio’s asset allocation that minimizes risk while maximizing returns is called “efficient.”

The Impact On Your Portfolio

So how does this impact your portfolio? It’s simple. Tracking the market has proven to have better outcomes, on average, than picking stocks or trusting managers to pick stocks for you. Furthermore, the fees associated with active investing can significantly drag down performance, thereby extending the years you are required to work.

If you decide to design your portfolio with passive investments, the great news is that it reduces your workload in that it requires few changes after the initial investment selections.  However, designing a proper allocation and sticking with it can be more difficult than it seems. An incorrectly allocated portfolio and investing strategy can be an expensive mistake.

Let’s look at a couple of appropriate allocations.  Let’s say you’re 30 years old and plan to retire when you’re 65.  You can likely afford to take a good level risk and put a big chunk of your money in equities.  Here’s what an allocation might look like for you:

Let’s say you’re 55 years old and don’t plan to retire until you’re 70.  You’ve got some other expected income streams, like social security and your firm’s pension fund, so you can still take risk in your portfolio. Depending on your other finances, you should not likely take the same level of risk as the 30-year-old.  Here’s what an allocation might look like for you:

Curious about a good target asset allocation for you?  Check out Personal Capital’s free Investment Checkup tool to get a personalized recommendation – and review of your existing allocation.

Want To Dig Deeper Into Your Portfolio?

As the single most important ingredient in long term investment returns, it is critical to understand the asset allocation of your entire investment portfolio.  Yet accurately identifying it can be challenging and time-consuming. That’s why spending a few minutes with a tool like Personal Capital is worth it.

In addition to analyzing your portfolio(s), Personal Capital can also help track your income, spending, assets and liabilities, and provide additional customized investment assistance. To grow your finances it’s important to first have a good grasp of your overall financial picture.