What Is Asset Allocation?
Asset allocation is a strategy of investment which makes an effort to balance risk against reward by adjusting the percentage of capital that is devoted to each asset that constitutes an investment portfolio.
Strategies that are used in asset allocation usually take into account the following:
- The risk tolerance factor of the investor
- The time frame for the investment
- Investment goals
- Amount of capital available for investment
- Assets selected for trade
Asset allocation is a key component of developing an investment strategy. If you have not considered it or used this strategy before, you should give it a try.
Selecting the Right Assets
Many traders simply jump into the market and start trading with no idea of how their asset allocation should be done. Some don’t even know what the concept of asset allocation is, and many have not even heard of it before. Asset allocation helps traders avoid unnecessary risk when investing.
Stated below is the role of each factor in determining the asset allocation of a trader’s investment portfolio.
Not every investor has the stomach for some of the wild swings that can occur in the financial market. Such investors are risk averse and will not benefit from trading risky investments. Such traders would be more suited to lower risk assets such as mutual funds. Those who enjoy the wild thrill can trade the riskier assets. It is therefore important to consider the investor’s risk profile. Risk profile in itself is also a product of several other factors.
Investment Time Frame
How long does an investor have in order to make use of the money devoted to the investment? This also determines the risk profile of the investor. For instance, an investor who is in his or her 20s has ample time to try risky investments, make mistakes and start over. There is still youthful strength and enough time to work and recover from past investment mistakes. A retiree investor, on the other hand, can no longer work at the same capacity as a youth and cannot afford any errors in investment. Therefore, the investment time frame will determine the asset allocation technique for these two types of investors.
Short term speculation will benefit from risky investments. If the investment goal is for something more long term, then the investor should look for more stable investments that present lower risk. The asset allocation pattern should mirror the investment goal of the trader in this regard.
Amount of Available Capital
Small capital is not suited for risky investments. The goal here would be to compound the investment until the capital can get to a point where the investment capital can accommodate riskier investments. If the trader has large capital, there is allowance in the asset allocation strategy to accommodate riskier investments ab initio.
If you have never considered asset allocation as part of your investment strategy, this is the time to do it. Understanding the assets you are trading are a vital element of successful trading.