Asset Allocation (AA) allows you to divide your investments to give the balance befitting of your risk tolerance. Get to know how.
AA simply allows you to divide your investments into general categories such as stocks, real estate, bonds, mutual funds, cash and private equity. The strategy is to lessen risk and increase income with investments with an understood correlation with the goal of aggressively or non-aggressively preserving and growing your capital based on your risk tolerance which will also invest in your proximity to retirement.
An AA model is typically decided upon by the portfolio manager and investor which require the portfolio to be placed in sectors where for example the portion allocated for stocks may have various percentages placed in large-cap, mid-cap, banking, manufacturing, etc.)
Asset Allocation Model selected by Investor Needs
generally understood that at various stages in life, your investment needs
would be different with the ultimate goal of accumulating the largest nest egg
for retirement. It is on this basis that AA models are based. For example, a
widow with one million dollars to invest and no other source of income will
look to invest a large portion of her portfolio in fixed income investments
that will generate a steady source of retirement income for the rest of her
life. The need here is to preserve the wealth while having a steady income to
live on. A young corporate employee just out of college will be more aggressive
looking to build wealth with a higher risk tolerance for market fluctuations as
his/her income for living is from the job. Investments under reasonable market
conditions that provide large capital growth will be a likely option. In this
case it could be growth stocks and short term emerging market real estate
investments might be some of the best options.
Asset Allocation Models
Majority of AA models are categorized into four groups or goals: Preservation of capital, income, balanced and growth models.
Model 1 – Preservation of Capital
This is designed for investors who expect to utilize their cash within the next 12 months and do not wish to lose any of it even for the potential of capital gains. Examples of uses of the money might be for paying for college, purchasing a house or a business or any major use in the near term. Investments that may be included in this model may be cash and cash equivalent types such as money markets, treasuries, commercial paper and others as a large percentage of the portfolio. As these investments have high safety nets the returns are typically lower and some of the associated concerns are that these lower yield returns may not keep up with inflation thus reducing purchasing power in real terms.