Understanding Asset Allocation
Asset allocation takes place when an investor or portfolio manager allocates capital to multiple kinds of investment vehicles along with strategies used to create hefty returns. Typically, investment managers utilize asset allocation to create a portfolio which will generate the returns which they are looking to achieve.
There is a finite strategy used when allocating assets within a portfolio. A portfolio manager will look at numerous asset types and attempt to balance these assets accordingly. Many of the asset types that an investor or portfolio manager will focus on are stocks, commodities, bonds as well as alternative investments along with cash.
The action of asset allocation creates a smorgasbord of assets which are invested and predicated on the investors risk/reward profile. There are numerous allocation techniques that an investor or portfolio manager can use to achieve and generate a diversified portfolio return.
Again, allocations within a portfolio are typically completed by an individual’s risk/reward outline along with their time horizon. Also, the greater the risk which is associated to the asset the greater the likely return of that asset. The investor or portfolio manager should implement a bushel of financial assets which are uncorrelated to one other to create and generate strong returns in many of these asset classes.
A strong example of asset allocation would be an investor who is over retirement age who would typically have a smaller tolerance to downside/risk, and would therefore be more intent in income producing financial assets then financial vehicles that garner capital gains.
Asset allocation by nature provides the greatest factors when trying to find the right blend of financial vehicles that will execute to the forecasted values over a specified time frame. Allocating funds to high-risk assets such as securities with high beta will typically generate portfolios with high volatility along with increased expected returns. On the other hand, a portfolio that is strictly cash and cash equivalents will be usually safe, but only generate extremely low returns.
The practice of allocation analysis provides investors and portfolio managers to produce a blend of investment vehicles that will execute to calculation over a specified timeframe. In the past, financial assets have not been correlated, which indicates that their overall movements don’t perform simultaneously. When an investor or asset manager holds riskier financial vehicles like common securities/stocks along with income type assets such as bonds this will generate returns in numerous market environments. Bonds are usually not as volatile as stocks which are typically purchased during times of economic softness.
Allocating assets is the main driver in finding the best mix of financial products that will perform to an investor or portfolio managers target assumptions over the course of time.
In closing, asset allocation is extremely important when an investor or portfolio manager is creating a well balanced portfolio. The portfolio manager along with the investor should keep in mind that to achieve their investment goals they need to create an investment strategy and stick to this strategy based on the their required returns.