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What is Asset Allocation?

An investor’s portfolio is often made of various assets including stocks, bonds and cash. The process of dividing up an investment among these different types of assets is called asset allocation. In other words, it is how you distribute your portfolio among different assets.

Asset allocation helps you achieve greater diversification in your portfolio by attempting to maximize the return of the overall portfolio at a risk level that is comfortable for you. Differing assets have different levels of return and risk: Historically, stocks have outperformed other asset classes such as bonds and money market funds, but have also experienced the most up and down movements, or volatility. Cash and money market funds typically have much lower returns, but are essentially riskless investments.

Depending on your age, investment goals and risk tolerance, your asset allocation strategy will be different. Generally:

  • If you are a younger investor, you may want to allocate a greater percentage of your portfolio toward stocks because you have a much longer investment horizon to recover from short-term market dips.
  • However, if you are nearing retirement age, a greater percentage of your portfolio should be allocated to bonds since capital preservation may be more important at this stage of your life.

Over time, it may be important to gradually increase your allocation toward more conservative assets such as bonds and decrease your allocation to stocks. A traditional rule of thumb for asset allocation has been to subtract your age from 100 to arrive at your proper allocation to stocks. Therefore, a 30-year old would have 70% of their portfolio in stocks and 30% in bonds and cash. However, with increased longevity and the low interest rate environment, some experts recommend subtracting your age from 110 or 120.

Jemma Everyday Wisdom: Asset allocation helps you avoid putting all your eggs in one basket by instead divvying-up the money you are investing into different types of assets. By diversifying across multiple asset classes based on your individual circumstance, an asset allocation strategy can help you meet your long-term investment goals.

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