Here’s an easy way to understand asset allocation
The allocation of your money to different types of investment assets, generally referred to as “asset allocation”, is the major factor that determines the risk level and performance of an investment portfolio as a whole.
For example, if you have all of your money in cash you have a low risk but relatively low returns. At the other extreme, if it is all invested in shares in Asian stock markets you may, over time, receive a much higher return but with a very much higher risk of experiencing negative returns – and stress – along the way.
Designing an individual’s asset allocation is very much like designing a piece of machinery. We know that different types of investment will provide certain average performances over lengthy periods. We also have a good idea of the probability of negative returns for investment types.
It is also a fact that different types of investment will perform better one year than the next. By allocating assets into certain combinations of investment types we can estimate the likely return over longer periods, and the risk of having a negative return in any one year. This is why each person needs to have their own asset allocation to suit his or her personal objectives and risk tolerance.
An example to make it easier to understand…
Chris is close to retirement and is becoming very conservative and cautious in his outlook. His asset allocation might look like this:
- Cash 10%
- Property 10%
- Australian Shares 25%
- International Shares 15%
- Bonds 40%
However, Travis is only 25. He has nearly 40 more years to retirement and just wants to see a maximum return on his money, while being happy to accept negative returns some years. His portfolio is illustrated below:
- Cash 5%
- Property 10%
- Australian Shares 55%
- International Shares 25%
- Bonds 5%
From these examples, we not only see different risk profiles but also allocations to higher income producing investments for Chris, who is nearing retirement.
As goals and attitudes differ greatly from one person to another, it is important your portfolio asset allocations are personally designed. Talk to a licensed financial adviser who has expertise in this area.
Leenane Templeton advisors are available on (02) 4926 2300 or email us today.