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Asset Allocation Thumbnail

Asset Allocation

Whether your retirement is years away or right around the corner, your investment portfolio should be designed with your financial goals in mind. It needs to be forward-thinking enough to handle the whims of the market but flexible enough to make changes should the need arise.

One of the most important concepts for any investor to understand is asset allocation. Put simply, asset allocation describes the division of stocks, bonds, and cash that make up your investment portfolio. Although this concept is straightforward, it has one of the largest impacts on your financial future.

Each asset class has its own set of risks and rewards, depending on your time horizon, risk tolerance, and financial goals. The asset allocation strategy you select will allow you and your financial advisor to create a framework that will be able to manage the level of risk your portfolio will hold based on the asset class. You and your financial advisor may make adjustments to your portfolio over the years as your needs change, however, having a selected strategy will help to keep the portfolio balanced and not stray from a healthy level of risk.

  • Stocks, also called equities, allow you to own a share of a publicly traded company. By investing in stocks, you have the potential for a higher return on your investment. But if the company has a bad year, or if the economy takes an unexpected turn, you may also lose money.1
  • Bonds, overall, have been a steadier source of fixed income. However, bonds are subject to interest rates and inflation risks, and their rate of return tends to be lower.
  • Cash and cash equivalents give you flexibility for any unexpected emergencies that may arise. If your hot water heater dies, having funds on hand to take care of it without resorting to a credit card is helpful. However, your cash-on-hand cannot earn you money the way other investments might.1

Finding A Balance

When it comes to managing your portfolio, asset allocation requires a more hands-on approach. “Setting it and forgetting it” may sound appealing, but changes in the market warrant a portfolio review to make sure your asset allocation still makes sense. Working with a financial advisor is a great way to make sure that your asset allocation reflects your goals, and they can help make adjustments to any changes that life throws your way.1 This process allows you to also gain a better understanding as to why your portfolio holds the assets it does.

If you are nearing retirement you may want to adopt a capital preservation strategy for your portfolio. In this case, you would potentially select a low-risk strategy and reduce the percentage of equities you hold in your portfolio and look to hold a few more bonds and cash or cash equivalent investments. These investments will allow for some potential returns with lower levels of risk. However, this is in theory and you should speak with your financial advisor before making such decisions. It is important to remain balanced and ensure that your investments are well allocated in their asset classes. The next step is ensuring your investments are diversified to help further manage the risks that come from being over-exposed to one sector, market, or economy. To learn more on diversification check out our blog post on understanding diversification or an interview Urs Vrijhof-Droese, WHVP managing partner, gave on Understanding Real Diversification.

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  1. https://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/articles/how-to-understand-future-focused-asset-allocation