Risk Management and Asset Allocation

Posted by: Joseph Kuo | May 13, 2022

One of the most important concepts for any investor to understand is asset allocation.

Previously, we covered the topics of dollar cost averaging and diversification as important elements of a sound investment strategy. Whether your retirement is years away or right around the corner, your investment portfolio should be designed with your financial goals in mind. It needs to be forward-thinking enough to handle the whims of the market but flexible enough to make changes on the fly.

One of the most important concepts for any investor to understand is asset allocation. Put simply, asset allocation describes the division of stocks, bonds, and cash that make up your investment portfolio. Although this concept is straightforward, it has one of the largest impacts on your financial future.

Each asset class has its own set of risks and rewards, depending on your time horizon and financial goals. You and your financial advisor may make adjustments to your portfolio over the years as your needs change.

  • Stocks, also called equities, allow you to own a share of a publicly traded company. By investing in stocks, you have the potential for a higher return on your investment. But if the company has a bad year, or if the economy takes an unexpected turn, you may also lose money. The more aggressive and growth-focused the investment strategy, the higher the percentage of stocks in the portfolio.
  • Bonds, overall, have been a steadier source of fixed income. However, bonds are subject to interest rates and inflation risks, and their rate of return tends to be lower. An investment strategy focused on asset protection will tend to have a higher percentage of bonds.
  • Mutual funds and ETFs (exchange-traded funds) are pools of multiple companies in which you can invest. While many mutual funds have a mix of stocks and bonds, some specialize in one or the other. Mutual funds offer less risk than investing directly in stocks, as funds typically invest in a basket of different stocks and thus come already partially diversified.
  • Cash and cash equivalents give you flexibility and liquidity for any unexpected emergencies that may arise. If your hot water heater suddenly needs replacement, having funds on hand to quickly take care of it is ideal. However, your cash-on-hand cannot earn you money the way other investments might. Cash and cash equivalents will also lose purchasing power over time as the cost of living rises due to inflation. 

Finding A Balance

When it comes to managing your portfolio, asset allocation requires a more hands-on approach. “Setting it and forgetting it” may sound appealing, but changes in the market warrant a portfolio review to make sure your asset allocation still makes sense. As the markets change over the years, your actual asset balances will start to vary from your original allocation and you will need to rebalance your account to maintain the ratios you have planned. Also, as you get closer to retirement and your life situation and goals change, updating your strategy will be necessary. Working with a financial advisor is a great way to make sure that your asset allocation reflects your goals, and they can help make adjustments to any changes that life throws your way.

To speak with an established financial advisor about your asset allocation strategy, contact me via email at joseph@abundancewp.com, or schedule a meeting by clicking the button below:

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