Asset allocation is the process of dividing an investment portfolio among different investment categories, such as shares, bonds, and cash, based on an individual’s goals, risk tolerance, and investment time horizon.
Studies have found that asset allocation is a significant contributor to portfolio performance, although the exact percentage can vary depending on the study and the time period analysed. One famous study suggested that 91.5% of an investor’s outcome is attributable to their allocation.
While the contribution to investment outcomes asset allocation makes might not be known exactly there is no doubt it is an important component of portfolio management. It should be the starting point yet investors can often get bogged down with lesser considerations such as picking suppliers and individual securities.
Once the asset allocation is determined there are other factors that can impact portfolio returns. The specific securities or investments chosen within each asset class can have a material impact on portfolio performance. Even within a single asset class, different investments can have vastly different returns and risk profiles.
Market conditions, such as interest rates, economic growth, and geopolitical events, can impact the performance of different asset classes and securities. It’s important to adjust asset allocation and security selection based on changing market conditions.
The investment strategy used, such as active or passive management, can impact portfolio outcomes. Active management involves selecting individual securities with the goal of outperforming the market, while passive management involves investing in a broad market index with the goal of matching market returns.
Risk management strategies, such as diversification and hedging, can help manage risk in a portfolio. Diversification involves investing in a variety of different asset classes to spread risk, while hedging involves using financial instruments to offset potential losses in a portfolio.
Fees and taxes can impact the overall return of a portfolio. High fees and taxes can eat into returns and reduce the effectiveness of an investment strategy.
It’s also important to regularly review and adjust investment strategies based on changing market conditions and individual investment goals.
A well-designed investment strategy should start with asset allocation and then take into account the other factors to help maximize portfolio returns and manage risk.
Working with a financial advisor can help ensure that investment strategies are aligned with individual needs and goals, and that all relevant factors are taken into account in portfolio management.
