Picture the future. What are your plans for 10 years from now? How about 5 years from now? One year? How certain are you that your plans will become a reality? Of course, the truth is we can and should plan, but we can never be certain of what the future holds. This also applies when it comes to investing.
Prominent investor Ray Dalio said, “you should have a strategic asset allocation mix that assumes that you don't know what the future is going to hold.”
So, what is asset allocation and why is it so important? Asset allocation is simply an enhanced, disciplined and more scientific version of the old adage “Don’t put all of your eggs in one basket.” It is a way to potentially protect against a major loss should things go awry in one investment class.
Asset allocation is a mix of investment asset classes, ideally based on your risk tolerance, time horizon and goals. The major asset classes are equities, fixed income, and cash alternatives. In addition to the major asset classes we may also want to consider other asset classes such as real estate and commodities. We can even dig a little deeper and we could say within equities, how much do we want to put in U.S. stocks, Asian stocks, European stocks, and so on. Similarly, with fixed income, we can decide how much do we want to put in long-term bonds, government bonds, corporate bonds, and so forth.
Generally, the longer time horizon you have before you will need the money the more it should be invested in equities. Over long periods of time, equities have generally outperformed fixed income and cash, but with more risk. If you are a younger investor you may want to consider putting more of your portfolio in equities. As you approach retirement you may want to gradually shift some of your equity exposure into fixed income and cash alternatives.
A downside to following a disciplined asset allocation strategy is that some portion of your portfolio will often be underperforming other parts. If equities are performing well, fixed income may not be doing as well. It can be frustrating to experience and the temptation will be to move more of your portfolio into the asset class that is doing the best. This is when it is important to remind yourself that maintaining an asset allocation strategy based on your risk tolerance, time horizon and goals is an established way to have more success with investing.
With so many things in life out of our control it can bring comfort to focus on things that we can control. Asset allocation is one of the few things that can be controlled when it comes to investing and it just may be one of the most important. Focusing on a disciplined asset allocation strategy rather than the whims of the market is a key component of achieving your personal financial goals.
If you have any questions about how to customize an asset allocation mix that is right for you or for any other financial planning questions, please feel free to reach out to your ACG Wealth Management team.