The crucial role of asset allocation

Julie Brownlee, Fsp Invest, 05 Mar. 2014

Tags: asset allocation, what is asset allocation, investing, investor, investment strategy, strategy, shares, stocks, bonds, property, gold, harry markowitz, risk, stock market,

Investing isn’t as easy as rushing out and buying a handful of shares. There’s more to it than that. Investing involves risk. And one way to spread that risk is to invest in different asset classes. That’s means expanding your investment portfolio to include other asset classes as well as shares. Let’s take a closer look at why asset allocation is so important when you invest…

You might think that investing is all about putting your money into shares, John Stepek in Money Week explains…

But there’s more to investing that that.

What if the current investing environment is hostile to shares?

For example, when there are periods of deflation, when prices are falling, bonds tend to perform better than shares. In times of inflation, and prices rise rapidly, that’s not good news for bonds, but it’s good for gold.

This means, that there are times when the best-performing assets are outside shares altogether.

So how can you deal with this?

Asset allocation 101: You need to spread your risk

You need to put together a portfolio of holdings that helps to spread your risk. And this means investing in shares that are in different companies and sectors, and investing in other asset types.

By spreading your investments across different asset classes, you hope to cut down your risk, without damaging your returns.

And it’s a proven theory. Harry Markowitz showed in the 1950s that by spreading your investments across different asset classes, you reduce risk. He won a Nobel Prize for his work.

The technical term for spreading your investments across different asset classes is asset allocation.

So, take a look at where you invest your money at the moment. This could include your pension, any shares you hold and any trading you might do.

And in case you’re wondering, don’t include your house as part of your portfolio. Everyone needs somewhere to live. But if you own a house that you rent out, on the other hand, include this as part of your investment portfolio.

By doing this simple task, you’ll be able to see if you have a lot of interest in one particular area. And you might notice there are areas you’re lacking exposure to.

So there you have it, the crucial role of asset allocation.

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