Asset Allocation and Diversification
“Asset allocation and diversification combined create opportunities for financial growth and balance, assuring sound asset management.”
Did you know that it is not necessarily the specific investments that you choose that control the outcome of your portfolio, but rather how you diversify your investing strategies? We refer to this as asset allocation.
Let’s Take a Look at How Asset Allocation Works for You
Asset allocation works because it helps to balance risk. Not all of the investments you make are the same, and by taking advantage of those differences, it’s possible to spread some of that risk over various categories of assets, such as bonds, cash alternatives, and stocks. There’s no way to ensure against any loss, but with this type of strategy, you may minimize some of that risk.
As you work to build your portfolio, you’ll find that different types of assets have different risk levels and, with that comes different potential rewards. What’s also important is how each of these different assets responds to changing market conditions. Most respond in different ways. That means if a downturn in stocks occurs, limiting your growth, you may still see improvement in other assets within your portfolio.
What Are These Assets?
There are three major types of asset classes used in asset allocation. This includes:
- Stocks – Stocks typically have a higher average rate of return than other investments (but remember, this doesn’t mean they will in the future). Stocks are more volatile, which means they can increase and drop in value quickly.
- Bonds – Historically, they are less likely to see those significant fluctuations in values like stocks, due, but they also have a lower earning level. They tend to react more to changes in interest rates. For those looking for regular income, this tends to be a good option.
- Cash Alternatives – Also known as short-term investments, these assets have a lower level of growth potential, but they also have the least risk, historically.
It’s suggested for most people to purchase all three types of assets. Then, within each classification, there are individual decisions to be made. Your goal, then, is to navigate these assets to find the best level of balance for your goals.
What Does Asset Allocation Offer to You, Then?
With asset allocation, the goal is to balance risk at a manageable level while still choosing high return investments. We can strategically spread-out investment dollars across various types of investments, helping to reduce those instances in which a sudden shock to the portfolio would otherwise tank it. Asset allocation balances change over time. It also helps investors make better decisions.
What Does Diversification Offer?
Diversification, in its simplest form, is about spreading your money around several investments. With asset allocation, the goal is not just to spread your investment dollars among different investments (such as different bonds or stocks), but also among different classes of investments. Asset allocation can include fixed income alternatives like cash equivalents and bonds. It can include other types of tangible assets, too. Diversification is the secondary step in building a portfolio. Now that we have numerous types of asset classes, we can work to further reduce risk within each one of those areas. When a portfolio is built on diversification, it is possible to have lower volatility and achieve better returns.
Just because you have asset allocation in place within your portfolio doesn’t mean you have enough diversification. It’s never ideal to have all of your money in one area, such as growth or value or small-cap or large-cap. Rather, it’s best to have every major investment category represented, meaning you should own multiple in every category.
Keeping with this goal, an important strategy is to determine which investments in each segment are going to perform differently depending on market conditions. For example, we may want to invest in a large range of companies or in different sectors instead of just one industry. By contrast, if you only invested in four or so individual stocks, you are not likely to have the diversification you need. Rather, it is best to have a dozen or more very specifically selected assets to achieve good diversification.
Investment advice offered through Musso Retirement Advisors, a dba of Advisor Resource Council, a registered investment advisor. Additional information, including management fees and expenses, is provided on our Form ADV Part 2, available at the SEC’s Investment Advisor Public Disclosure website. As with any investment strategy, there is potential for profit as well as the possibility of loss. We do not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results.
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