Asset allocation is a critical factor in determining the long-term return patterns of your portfolio. Asset allocation also helps you and your financial adviser determine the trade-off between risk and return that suits you.
Asset allocation refers to diversifying your investments into different categories with different risk levels. An asset can be anything from your home to your right to collect royalties on a book that you wrote1. But when people describe asset allocation, they’re usually talking about money that you invest in the stock market or in your superannuation fund. This money is invested in three main ways:
1. You buy companies. When you buy a share, you’re buying equity. When you buy BHP Billiton shares, you become a part-owner of the company. You have equity in BHP Billiton.
If you don’t want to buy shares directly, you can buy a fund that holds shares in several different companies. Index funds, for example, are collections of lots of different types of shares, bundled together in one basket.
Different shares have different levels of risk; however, they are generally accepted to be higher risk than fixed-interest or cash.
2. You give loans. When you buy a bond, you’re giving out a loan to whatever group issued (asked for) that bond. If you buy a corporate bond, you’re giving a corporation (company) a loan. If you buy a government bond, you’re giving the government a loan. The company or government must pay you interest on that loan. It has a “payment plan” on a fixed timeline. For example, it might pay you interest once a month, or once every three months.
That’s why this is called a “fixed-income” investment: you get income on a fixed schedule.
Government bonds are considered incredibly low risk because the risk of the government not paying you, or going “bankrupt”, is incredibly low.
3. Or you keep it in cash. Self explanatory.
Asset allocation means that you spread your money between a combination of these three categories: equities, fixed-income and cash. There are several common “combinations” of these categories that you may have heard of:
We will consider several factors when developing an asset allocation that’s appropriate for you, including:
Determining the amount of investment risk you can tolerate is essential. We will examine your income, investable assets, investment goals – even your attitude about risk – to determine the risk/return trade-off that’s right for you.
Periodic rebalancing should be considered
Your needs, goals, and investment time frame change over time. So, too, does the market. One of the ways a financial adviser adds value is by monitoring and periodically rebalancing the asset allocation of your portfolio.
Together with us, you can review your investment plan to make sure it stays on track to meet your short- and long-term investment goals.
Asset allocation can influence returns
Holding more shares in a portfolio has historically resulted in higher average annual returns but greater risk. The chart below illustrates how a portfolio made up of 100% shares delivered an average annual return of 10.8% significantly higher than the 7.1% average annual return of a 100% bond portfolio2. The trade-off for that significantly larger return was a much greater exposure to the risk of loss.
Fortress Financial Solutions founder Chris Black is an award-winning financial planner based in Toowoomba who specialises in superannuation, investing, business succession, cash flow management, retirement planning and personal insurances (including life insurance, income protection, total permanent disability and trauma insurance).
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