Every investor should learn more about asset allocation. It is a very important part of creating and balancing your investment portfolio. It is worth noting that it is one of the main factors that lead to your overall returns – even more than choosing individual stocks.
Establishing an appropriate asset mix of stocks, bonds, cash, and real estate is a dynamic process. Let’s have a look at several different strategies.
We can start with a strategic asset allocation. Interestingly, this method establishes and adheres to a base policy mix – a balanced combination of assets based on expected rates of return for each asset class. Moreover, investors need to consider their risk tolerance and investment time frame. Investors have the opportunity to set their targets and then rebalance their portfolio every now and then.
This method may be akin to a buy-and-hold strategy. Furthermore, it heavily implies diversification to cut back on risk and improve returns.
Another strategy is constant-weighting asset allocation. Usually, strategic asset allocation implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. So, investors may prefer to adopt a constant-weighting approach. With a constant-weighting approach, investors continually rebalance your portfolio.
Importantly, there are no hard-and-fast rules for timing portfolio rebalancing as part of strategic or constant-weighting asset allocation. However, a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.
Asset allocation and important details
People should keep in mind that, over the long run, a strategic asset allocation may seem relatively inflexible. As a result, investors may find it necessary to occasionally engage in short-term, tactical derivations from the mix to capitalize on unusual or exceptional investment opportunities. Interestingly, tactical asset allocation can be described as a moderately active strategy.
Let’s have a look at other strategies as well. With dynamic asset allocation, investors constantly adjust the mix of assets as markets rise and fall. They also adjust the mix of assets as the economy strengthens and weakens. With this strategy, investors sell assets that decline and purchase assets that increase.
Thanks to an insured asset allocation strategy, investors establish a base portfolio value under which the portfolio should not be allowed to drop. Importantly, if the portfolio should ever decline to the base value, you invest in risk-free assets, so the base value becomes fixed.
With this strategy, investors consider their economic expectations and risk in establishing an asset mix. Not all strategies stated above account for the investor’s risk tolerance. As a reminder, that is where integrated asset allocation into play.
Notably, this strategy includes aspects of all the previous ones. It is a broader asset allocation strategy. Nevertheless, it can not include both dynamic and constant-weighting allocation since an investor would not wish to implement two strategies that compete with one another.