Financial Quotient

What is asset allocation?

WHAT DOES IT MEAN?

Asset allocation refers to the strategy of dividing an investment portfolio across different asset categories such as stocks, bonds, cash or other alternative investments like real estate or precious metals.

WHY IS IT IMPORTANT?

Asset allocation helps to diversify an investment portfolio and balances risk and returns.

Each asset class has a different level of risk and return, and performs differently over time and in different market environments. By holding a mix of asset types, you can reduce the overall risk and volatility of a portfolio while maximising potential gains.

For example, bonds might suffer during an interest rate hike, but by allocating a portion of the portfolio to stocks, alternatives and cash, it can effectively minimise the loss from bonds.

Finding the right asset allocation strategy largely depends on your financial objectives, time horizon of investment and your risk tolerance.

In general, a millennial investor saving for retirement would have time to grow assets and ride out short-term market fluctuations and might allocate more to riskier assets with higher potential returns, compared to a retiree looking to guard his wealth, who may be more conservative.

It is important to review the portfolio from time to time, either to rebalance the investments in order to maintain the original asset mix, or to change the asset allocation as you near the investment goal, or if there are changes to your risk appetite, financial situation or to the investment objective itself.

IF YOU WANT TO USE THE TERM, JUST SAY:

"Asset allocation is much more essential when it comes to explaining investment returns compared to market timing or individual stock selection."

A version of this article appeared in the print edition of The Sunday Times on December 24, 2017, with the headline 'What is asset allocation?'. Print Edition | Subscribe