By Robert Blando
By following a well-formulated asset allocation strategy, you can stabilize your portfolio and increase your peace of mind at the same time.
But what exactly is asset allocation?
Simply put, it is a strategy for answering two questions: What type of assets should I have in my portfolio?
How much of each should I have?
I cannot overstate the importance of asset allocation when it comes to building a successful portfolio. Asset allocation provides you with a roadmap for selecting appropriate investments, and for rebalancing your portfolio before, during, and after market volatility. As such, it is one of the cornerstones of successful investing.
The rationale for asset allocation
The idea of asset allocation is an old one (at least as old as the saying, “don’t put all your eggs into one basket”). But the idea really took off in the late ‘80s, when investment whiz Gary Brinson (whose financial research in the subject has become one of the cornerstones of modern investment strategy) discovered in an investigation that more than 90 per cent of portfolio performance could be attributed to how assets were allocated. Slightly less than five per cent was accounted for by the actual securities held, while less than two per cent was due to market timing.
In other words, asset allocation turned out to be 10 times more important than everything else put together! Successful asset allocation begins with a simple rule: we should all look for the combination of assets that gives us the greatest potential return for an appropriate level of risk. The right asset allocation for you may not be the right allocation for me, depending on the difference in our personal risk tolerance, but the principle comes down to this: take on as much risk as you have to in order to accomplish your investment goals. And no more.
How do I begin?
You can start by asking yourself a simple question: “Given my personal risk tolerance, and individual objectives, what portion of assets should I allocate for growth, what portion for income, and what portion for liquidity?” This is the secret to successful asset allocation – figure out what you are trying to accomplish with your investments, and then organize your portfolio in the way that is most likely to make those goals a reality.
Putting asset allocation to work
Once you’ve outlined your investment objectives, you should be able to determine an appropriate asset mix. If it’s growth you’re after, you’ll want to allocate a significant amount of your wealth to equities, which have historically outpaced other assets when it comes to growth. If your objective is income, you’ll want fixed-income investments such as bonds, preferred shares, and perhaps income trusts or real estate. These investments offer the most consistent income flow. And if the goal is safety and liquidity, short-term investments such as GICs, T-bills, or money market mutual funds will dominate.
No matter what your objective, you’ll want to reserve a portion of your portfolio for each of these main categories. Such a balance will make market volatility a lot less of a problem in your portfolio, and will help you sleep better at night.
Robert W. Blando is a senior wealth advisor for ScotiaMcLeod, a division of Scotia Capital Inc. He can be reached at 204-946-9223 or firstname.lastname@example.org.
This column is intended as a general source of information and should not be considered personal investment, tax or pension advice. The information, opinions and conclusions contained in the column are protected by copyright.