As there are a plethora of options available for mutual funds and stocks on the market, even the most experienced investor becomes confused while choosing the right investment. If done in the wrong way, an investment can take off all your hopes to build great wealth and can make things fall apart disastrously. Therefore, it becomes extremely pivotal to be cognizant of the best way to do it.
So, what should you do?
Rather than picking up stocks, you should identify what mixtures of stocks, mutual funds, or bonds will be ideal for you to hold. This is simply known as ‘asset allocation’. This post will highlight seven important factors that you should consider in your asset allocation plan to shake things up. However, before we move straight to this main thread, let’s first discuss something more of asset allocation.
Here we go!
What Is Asset Allocation?
Asset allocation is an innovative investment strategy that involves dividing asset classes into major categories such as stocks, real estates, bonds, derivatives, etc., with the primary aim to mitigate the level of investment risk.
Each asset class possesses distinct levels of risks as well as returns; therefore, it gives us the reason why they behave differently from one another. One asset category may perform differently by increasing the value, while another one might not do the same. The majority of investors consider it as the best ever protection against major losses.
According to various financial professionals, asset allocation is one of the most pivotal decisions taken by investors. The way an investor allocates the assets prioritizes over his/her selection of stocks, bonds, or mutual funds.
Three Major Categories
Broadly speaking, there are three categories under which asset classes fall. They are:
- Cash & equivalents
If any asset class falls out of these three categories, it is referred to as an ‘alternative asset’.
Simple Example of Asset Allocation
Let’s say you are planning to retire at the age of 60. You are into a service and you receive a monthly income of $50,000. You are currently 45 years old and have a net worth of 2 million dollars. You are ready to contribute $20,000 every month for your portfolio and you also are planning to withdraw $50,000 every month after your retirement.
What should be an ideal asset allocation plan for you?
Here is this:
Stocks = 40% (Because you still have 15 years to get retired.)
Bonds = 50% (It will keep your money safe.)
Equity = 10%
Factors to Consider While Planning Asset Allocation
Risk Tolerance – Are You A Real Risk Taker?
Risk tolerance simply means your ability and willingness to lose a particular amount of investment to get extensive positive outcomes in return. If you are willing to take high risks, your portfolio will provide you with great equity. If you are willing to take risks at a relatively low level, then you will end up with the instruments of fixed income. However, if you wish to keep it at a moderate level, then you probably get a respective blend of equity and fixed incomes.
But, how will you define a real risk?
Just because you are taking risks while keeping your eyes closed and anticipating the higher returns from your investments doesn’t make you risk-tolerant. A real risk-taker will always carry out the processes with secure assets. He/she will invest aggressively when the valuations will be lower. He /she will chunk out undervalued assets to prevent the portfolio from falling down. He/she will only take the risk when things are highly in favor.
Time – It Is Your Best Friend!
In order to leverage the maximum benefits from time, you need to understand the time value of money. Having time simply means you can put higher risks into your investment portfolio or you can get higher returns from your investments because the dynamics of the economy remain inconsistent, and it may change in favor of the investor. A stock that is not so valuable right now might turn into a substantial one after 5-6 years. Therefore, it is extremely pivotal to set a time horizon for the investment and it depends majorly on the fact that for how long an investor is going to invest.
Expenses – Don’t Burn Holes In Your Pocket!
It is utterly crucial to keep your expenses low for everlasting success. Therefore, make sure to avoid all unnecessary and extravagant expenses and keep your financial health always green for the long-term. This is the ultimate key to save a large portion of your earnings that can be deployed for other important tasks.
While certain expenses cannot be ignored such as rent and bills, you can smartly identify what types of things are causing more expenditures. Just spot them and leave no stone unturned to avoid them so that you can fulfill your financial goals.
Diversification–Use It correctly!
There is no doubt in the fact that diversification is one of the most important strategies in the realm of investing. However, most investors fail to do it accurately. Some welcome a plethora of catastrophic errors by doing under-diversification, while others make things worse by over-diversification. Investors end up with many negative results by purchasing expensive assets in anticipation of maximum benefits from diversification.
Therefore, smartly diversify your portfolio by incorporating various factors such as international and dividend growth. Choose the assets that can provide you with higher values along with subtle diversification.
Rebalancing – Align It All!
Rebalancing is a highly effective process of keeping the weights of portfolio assets in an aligned manner for significant risk management. Let’s say, the previous asset allocation plan for investment was 60% stocks and 40% bonds and it delivered positive outcomes. The changed plan doesn’t perform well during a significant amount of time, therefore, there is a need to get the portfolio back to the original allocation of 60/40. This is known as ‘rebalancing’.
Specific Goals – Understand Their Relevance!
While doing financial planning, goals play a pivotal role in leading you to the path of success. Whether you wish to build a dream house, to complete a demanding business project, to fulfill your child’s education needs, to buy a new car, or to go for a long vacation, you need to determine specific goals in your asset allocation plan.
Let’s say you aspire to pay for your child’s educational needs in the future. Now, your asset allocation plan will primarily focus on fixed-income investments. And once you will get retired, you may need higher proportions of fixed-income investments to never run out of money for your child’s education.
Assets & Liabilities – Think Before You Act!
If you are having increased liabilities, you are actually taking a lot of risk while investing. Your investment will not be safe anymore and it might make your financial conditions worse. Similarly, it is extremely important to analyze assets before allocating them further. One needs to have a clear and precise understanding of which assets to buy and how much proportion of each asset to hold up. While keeping in mind the liability and asset factors, you can avoid many negative outcomes.
The Bottom Line
Building an asset allocation plan is not an easy and one-time process. It requires extensive knowledge, valuable skills, a keen eye for detail and time-to-time reviewing of asset allocation. When created correctly, the asset allocation plan can save your portfolio from various misfortunes and can assist you in transforming your dreams into a beautiful reality. With Wealthface, you don’t need to worry about it any longer. By choosing us as your financial partner, you can leave everything to us and live with ease. From portfolio construction to its management and updating, we take care of everything and grow your money.
If you want to know more about asset allocation plans, visit https://wealthface.com/ today!