Asset Allocation and Risk Allocation
With current market instability, inflation, and rising interest rates, more people are becoming acutely aware of the risks of investing. Financial markets are commonly known for their up-and-down nature, also known as market risk.
Some people go into the market with higher expectations than others, but those expectations often come with an equal amount of risk. Others have a lower tolerance for risk and are more comfortable with the possibility of lower returns.
But, regardless of risk tolerance, a portfolio that’s ill-prepared to cope with volatility may experience some long-term consequences.
Back to Asset Allocation Basics
For many, asset allocation is their preferred investment strategy for focusing on long-term investing and striving for a balance between mitigating risk and returns over time. This strategy is centered around choosing a mix of asset classes based on your profile, investment goals, risk tolerance, and timeline.
The belief is that, by choosing a mix of assets, the assets will counter-balance each other in hopes that the portfolio doesn’t tip too far in one direction. Balanced and diversified portfolios often have a mix of asset classes, like stocks, bonds, precious metals, real estate, and more - all with varying levels of correlation to each other.
Allocating for Risk
All investments are susceptible to risk; whether it’s market risk, inflation risk, interest rate risk, taxation, or liquidity risk. A comprehensive asset allocation strategy is as much about allocating risks as it is about allocating assets, and has the potential to mitigate the portfolio’s risk by offsetting the performance of various asset classes.
Although asset allocation doesn’t guarantee your account will be protected against losses in a declining market, a properly allocated portfolio may be more stable during times of change and uncertainty because portions of the portfolio may respond more favorably in certain conditions.
Portfolios often require ongoing adjustments, also known as rebalancing. Different parts of your portfolio may under or outperform expectations and may become unbalanced based on the assumptions the allocation was based on.
A disciplined rebalancing strategy forces you to buy more of an asset class after it falls to bring it up to the target allocation. The reverse is true about an asset class that rises above your target allocation. Rebalancing simply forces you to buy low and sell high.
The only certainty about the market is that it’s uncertain and it will change, so it’s important to review your investment strategy with a financial professional regularly so your portfolio stays aligned with your needs and goals.
This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2023 Advisor Websites.