Importance of asset allocation
At this point hopefully you will have some understanding of several key investment principles, and now we discuss a key factor which has a big influence on your retirement planning, and one that you have full control: Asset allocation.
We can spend many pages going into very technical details about asset allocation, but we will just use the Wikipedia’s description.
Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor’s risk tolerance, goals and investment time frame.
That’s it. The one key word here is balance, the balance between risk and reward, the return of your overall investment. This balance is decided based on your risk tolerance, goals and investment time frame.
Going back to the scatter chart of “Investment Principles”, what should you invest in?
If you have moderate risk tolerance, and you are investing for your retirement that is still some years away, perhaps a 50-50 equity / bond balanced Portfolio (3) will offer you that balance between risk and reward.
Too risky, how about the balanced Portfolio (2)? Or maybe this balanced Portfolio (4) instead if you are willing to be exposed to higher risk with potential for higher return?
Regular portfolio rebalancing
So you have selected a balanced portfolio that fits you, but at the end of the year, you find that the weighting of each asset class in your portfolio has changed! What happened? Over the year each asset class within your portfolio has moved up and down in prices, resulting in a weighting change.
Rebalancing your portfolio will help you maintain your original asset-allocation strategy.
Comparison of portfolios with rebalancing and no rebalancing (June 2008 - June 2018)
Finding and managing a balanced portfolio that best fits your life is very achievable, and you have full control of a little step towards this, and towards a future where you can live your best life.