Building a healthy-sized retirement nest egg takes careful and strategic planning. Ideally, individuals want to start as young as possible to better leverage risks without losing money, and to use the “don’t put all your eggs in one basket” approach.
Managing large investment portfolios requires a more sophisticated investment strategy because you want to balance risk, yet earn a good return on your investments, especially if you expect to be on a fixed income later in life.
Proper asset allocation is crucial for large portfolios as it balances risk and return, ensuring long-term financial stability and growth. Asset allocation can be a cornerstone of how you approach your investments and can play a significant role in accomplishing financial goals. One of the keys to successful asset allocation is calculated diversification.
In this article, we’ll define asset allocation and discuss different strategies associated with balancing your investments.
Understanding the Asset Allocation Model and Strategy
Many financial professionals will recommend putting assets into a variety of categories. Since economic and political conditions can directly have an impact on your investment portfolio, by diversifying you can give yourself a cushion; if one investment is flat or goes on shaky ground, your others might provide solid growth.
Asset allocation aims to diversify a portfolio across different asset classes to spread out risk while trying to capitalize on your best ROI options to yield returns in alignment with your financial goal’s target date. There are various asset classes people invest in.
The following outlines primary asset categories and provides brief explanations of each.
1. Stock Investments
When an individual buys stock, they purchase a “slice” of ownership in a company and are entitled to receive portions of its profits. Investing in stocks is a good option for people who prefer to be an aggressive investor to get higher returns.
While investing in the stock market can result in a great return on your investment if a company does well, it’s important to know stock investments are riskier than other investment options.
You should discuss the amount of stock allocation you want to invest with a registered investment adviser to better understand the higher risk associated with stocks, especially if you tend to be a conservative investor.
2. Bonds
Unlike investing in the open stock market, bond funds work a little differently. Purchasing a bond is essentially loaning money to a company, the federal government, or other public entity.
You will receive your principal amount back, along with a percentage of interest. These are perfect for individuals with lower risk tolerance, but the return on investment (ROI) isn’t as high either.
3. Cash equivalents
Cash and cash equivalents (e.g. CDs, money market accounts, etc.) tend to be a safer and more accessible type of investment. You always have either immediate access or, if not, you don’t have to wait too long to withdraw your money.
For the most part, you will not incur losses, but it’s important to keep in mind, you won’t get a huge ROI from cash and cash equivalents. This might cause you to not reach your target date funds if you expect to be on a fixed income when you retire.
4. Real estate
Real estate is often an attractive option for investments, as you can diversify in many ways. You can invest in:
- Residential properties for short-term rentals (vacation, Airbnb, VRBO, etc.)
- Residential properties for long-term rentals (e.g. leased tenants)
- Commercial and industrial properties
- Househacking (a multi-family home where you rent out part and live in another part)
- Real estate investment trusts (REITs)
- Real estate investment groups (REIGs)
The latter two are ways to pool your money with many investors which can help spread out your risk exposure. While real estate can yield an excellent return, it’s important to remember:
- Success is tied to the economy, market conditions, and other factors
- There are pros and cons to investing in the different types of real estate asset categories
- It might be difficult to sell a property quickly if you decide to move your wealth elsewhere, are close to meeting your target date fund and need to exit, or need fast cash (e.g. you are now living on a fixed income that isn’t enough to support yourself)
5. Commodities
Commodities are raw materials often included as part of a financial portfolio. These items are used to produce other goods and services. Common examples include:
- Gold and other precious metals
- Industrial metals (e.g. zinc, copper, lead, etc.)
- Energy resources such as oil and natural gas
- Crops (e.g. corn, soybeans, wheat, sugar, coffee beans)
- Cattle
Commodities are often a volatile asset class, including them in your portfolio offers diversification benefits but can come with higher risks. It’s important to consider these are directly connected to inflation risk which might impact your level of risk tolerance.
Spreading Your Investments Can Strengthen Your Investment Horizon
Spreading your asset allocations across these and other asset classes helps to mitigate risk through negative correlation because different asset classes offer levels of risk and reward. In other words, if one asset class fails, another may see solid growth.
Ready to connect with a financial professional to discuss how to spread your investment in different asset classes? Use Our Free Advisor Match Tool
Strategic vs. Tactical Asset Allocation Models
Managing investments easily becomes complex with all the different options, levels of risk, and levels of return. It can be difficult to decide what the best course of action is to take.
Understanding the differences between strategic and tactical asset allocation is vital. Each type of investment process presents unique risks and returns, so you want to ensure you know what you’re “getting into” before investing in various asset categories.
What is Strategic Asset Allocation?
Strategic asset allocation is a long-term investment philosophy following fixed investment guidelines. It sets the target weightings for each asset class based on your risk tolerance and financial goals. This approach keeps your portfolio balanced and steady.
What is Tactical Asset Allocation?
Tactical asset allocation is making short-term adjustments to your long-term strategic plan based on market opportunities or economic forecasts. It looks to capitalize on short-term market inefficiencies or imbalances, providing an ability to help your portfolio exceed strategic benchmarks and earn more money.
Working with a skilled financial advisor can help you develop a strategic plan that aligns with your comfort level when it comes to risk. Get matched with a financial advisor.
Asset Allocation’s Impact on Performance
Asset allocation can have a greater impact on your portfolio’s performance than individual security selection. This is especially true if you possess a large portfolio of assets.
Safer allocations will yield less ROI, but will stay tucked away for you to easily access in the future. On the other hand, high-risk investments will yield excellent returns but can be easily lost if market conditions decline.
Knowing how to invest, when to invest, and when to shift assets is essential. Strategic asset allocation helps manage risk by balancing exposure to growth-oriented assets with more stable options, aiming to achieve desired return objectives.
Advanced Allocation Strategies
Investors can also look to specific advanced asset allocation models and/or strategies to help them realize their financial goals. Let’s take a look at other ways you can manage a large and diversified portfolio.
Modern Portfolio Theory (MPT)
MPT is a framework for constructing optimal portfolios with the lowest tolerable risk for a given expected return. MPT assumes investors are risk-averse and will always seek out more conservative asset allocation options for their portfolios.
Diversification is a core component of the MPT approach. In other words, placing assets in different classes is less risky than investing money in a portfolio of similar assets. Investors often consider MPT to be a useful tool because it helps them identify a wider range of asset classes and helps determine the best options.
The goal with MPT is to assemble a portfolio comprised of multiple assets to yield a strong ROI without the high-risk components accompanying certain types of investments.
Other Allocation Models
Several other allocation models exist, such as risk parity models and factor-based investing, which might be suitable for large portfolios.
While there is no such thing as a “no risk” strategy when it comes to investment goals, risk parity seeks to balance risks within a portfolio, so it’s not only diversified just by asset class but by diversifying risk levels as well.
Factor-based investing focuses on diversification but is more aligned with selecting securities typically associated with higher returns by leveraging macroeconomic principles.
Other ways you can achieve asset allocation is through establishing an income portfolio, balanced portfolio, and/or growth portfolio. Each serves a specific purpose which will depend upon your current situation, future goals, age, and risk tolerance.
Portfolio Rebalancing
Another important step to consider is to rebalance your portfolio. What portfolio rebalancing entails is the process of periodically adjusting asset weights back to their target allocations if market movements cause them to deviate.
Since market conditions frequently alter the value of asset classes, a portfolio may experience low growth points. Rebalancing can help to correct this by helping you maintain an investment that aligns with your original asset allocation.
When you rebalance your portfolio you can better maintain your desired risk profile while preventing emotional investment decisions based on short-term market fluctuations, which is crucial for the long-term success of large portfolios. A good time to consider rebalancing is when you conduct your annual review of your investments.
The Portfolio Asset Allocation Model Inclusions is a Key Component in Managing Your Investments
Due to the fact large portfolios can be so complex, the adage of spreading one’s “eggs” in different “baskets” applies to a high degree. The integration of asset allocation helps to manage risk, optimize returns, and help to achieve one’s financial goals.
It can be challenging to navigate the complexities that accompany managing large portfolios. Receiving guidance from qualified financial advisors who can help steer you in the right direction is a great place to start. Experienced financial experts can help you to:
- Establish your financial objectives
- Create asset allocation funds
- Determine the right asset target allocation
- Find the right balance of how you want to allocate your assets into the different asset classes
- Balance your risk levels with your expectations of investment returns by your target date
- Identifying potential new investments
- Choose a target date
- Integrate all of the above into your overall strategy to help you meet your investment objectives
Find a financial advisor who can help guide you on your personal finance goals, including your investment strategy, retirement fund, and creating your asset allocation fund, along with helping you to develop a diversified portfolio and set a target date for your goals. Get matched today!
*The information provided on this site is for informational purposes only and should not be construed as financial advice. Invested Better does not guarantee the accuracy or completeness of the information provided. Please consult with a licensed financial advisor before making any financial decisions.”
**Investing involves risk, including the possible loss of principal value. Past performance is not indicative of future results.
