What is Asset Allocation?
Asset allocation is the process of dividing investments among cash, equities (ex. U.S. Large Cap, International), fixed income (ex. Taxable, Municipal) and cash equivalents to optimize the balance between risk and reward based on investment needs.
What Should my Asset Allocation be by Age?
As a general rule, your target asset allocation can be determined by subtracting your age from either 100 or 110. The resulting number is the approximate percentage of assets you should allocate to stocks. For example, at age 50, this would leave you with 50 to 60 percent in equities, depending on your risk tolerance.
What are the Types of Asset Allocation?
A suitable asset allocation strategy is important because it can prevent turmoil during the next market correction.
The main categories of asset allocation include the following:
- Strategic Asset Allocation, similar to a buy and hold strategy, establishes a base policy – a combination of assets based on factors such as expected rates of return for each asset class, risk tolerance, time horizon, and investment objectives. This suggests that they’re typically a diverse mix of assets.
- Constant-Weighting Allocation involves continuously rebalancing your portfolio, which should be rebalanced to its original allocation when any given asset class moves 5% from its original value and typically includes buying low and selling high.
- Tactical Asset Allocation is a strategy that allows tactical deviations from an established allocation to take advantage of unusual short-term investment opportunities, adding a market-timing component to the portfolio.
- Dynamic Asset Allocation involves constant adjustments to the allocation of assets as markets rise and fall. This is the opposite of the constant-weighting strategy but does also typically include buying low and selling high.
- Insured Asset Allocation involves establishing a base portfolio value, and investing in risk-free assets (treasuries), in the case that the portfolio ever drops below its base value.
Integrated Asset Allocation is the use of a combination of all of the above strategies. However, one cannot use dynamic asset allocation and constant-weighting strategy at the same time, as they are contradicting methods.