Asset allocation is the process of selecting a mix of asset classes that closely matches an investor’s financial profile in terms of their investment preferences and tolerance for risk. It is based on the premise that the different asset classes have varying cycles of performance, and that by investing in multiple classes, the overall investment returns will be more stable and less susceptible to adverse movements in any one class.
All investments involve some sort of risk, whether it’s market risk, interest risk, inflation risk liquidity risk, or tax risk. An individualized asset allocation strategy seeks to mitigate the risks of any one asset class though diversification and balance.
An investor’s allocation of assets will reflect his or her desired goals, priorities, investment preferences and tolerance for risk. Each individual’s strategy is built on the careful consideration of the key elements of their financial profile, which include:
Investment Objectives: What the investor hopes to achieve using their investment dollars. This could include
– improvement to current lifestyle, achieve capital growth, fund a specific goal, etc.
Risk Tolerance: This reflects the investor’s comfort level with market fluctuations that can result in losses. Inflation risk and interest risk must also be considered.
Investment Preferences: An investor may prefer one asset class over another based on a certain bias or interest towards the characteristics of that class.
Time Horizon: The length of time an investor is willing to commit to achieving their objectives.
Taxation: Investing in a mix of asset classes will have varying tax consequences.
An Evolving Strategy
A sound asset allocation strategy includes periodic reviews.
When it comes to the financial market, the only certainty is that changes will occur – its inevitable. As will your financial situation.
As people move through life’s stages their needs, preferences, priorities and risk tolerance change and so too must their asset allocation strategy. Through market gains and losses, a portfolio can become unbalanced and it is important to make adjustments to allocations.