What Is Asset Allocation?
- Learn about what asset allocation means and how it can help you reach your financial goals. Find out which asset allocation model is right for your situation.
You can maximize the benefits of your savings and retirement funds by making the right investments. The best choices for your money may depend on your situation, age and financial goals. Asset allocation refers to how money in your portfolio is distributed among various kinds of investments.
What Is Asset Allocation?
Different types of investments can exist within your portfolio. These include:
- Stocks from individual companies
- Exchange-traded funds, or ETFs
- Money market funds
- Certificates of deposit, or CDs
Asset allocation can describe the amount or percentage of your portfolio in each type of investment. Asset allocation models range from conservative to very aggressive.
What Are the Models of Asset Allocation?
There are different terms for asset allocation models. Many investors use a scale of " very aggressive" to "conservative" for describing models.
Conservative models place most assets in cash or cash equivalents, such as CDs. These models are focused on capital preservation. They probably won't increase much in value, but they also aren't likely to lose any money. Conservative models may invest some funds in stocks, but the stocks are usually in large, well-established companies with reliable values.
Aggressive models place more funds in stocks and may experience significant gains and losses. These models may involve investing in new companies or international stocks.
Moderate models fall between conservative and aggressive models. Moderate portfolios incorporate some conservative investments as well as riskier options in their mix.
Some investors use different terms, but the rationale is the same. For example, Vanguard uses the following classifications:
- These models are conservative and intended to be low-risk while providing steady income or retirement funds.
- These moderate models balance low-risk investments with assets that have the potential for more growth.
- These models invest in more aggressive asset allocation.
Knowing these terms can be helpful when investing. Understanding these models can help you know how to invest assets, and it can help financial advisors understand your goals. However, many ways exist to invest your assets to accommodate your needs.
What Is a Good Asset Allocation?
There's not a universally good or bad asset allocation model. However, it's best to consider your financial goals when choosing investments. Some factors may impact how you should allocate your assets:
Risk Tolerance and Goals
How comfortable you are taking risks with your money affects how you prefer to allocate assets. Very aggressive allocation models can be a gamble. These models usually involve assets that are mostly invested in individual companies, some of which may be newer businesses. These investments can offer huge returns, but they can also involve the risk of loss if the company isn't successful.
Aggressive models are often used by those hoping to grow their wealth over time since they can handle temporary setbacks. More conservative models may be better for people who need to save money without risks.
Age and Time Horizon
Time horizon refers to how long you'll leave your money invested before you need to access the funds. If the money is for retirement, your age has an impact on this. If the money is for another purpose, such as a child's education or as part of a life insurance plan, think about when the money is likely to be needed. Consider how quickly you need the investment to grow and whether short-term losses due to market downturns would be tolerable. Generally, if you have a long time horizon, you can tolerate more aggressive asset allocations. Short-term ups and downs won't matter in comparison to the long-term gains.
In any case, some diversification of assets is usually a good choice. Diversification means investing assets in different companies or types of accounts. You'll still have other funds if one investment doesn't work out or loses money.
What Is an Example of Asset Allocation?
The following are some examples of what you might expect from different asset allocation models.
Examples of portfolios based on conservative models:
- 10% cash, 75% bonds and 15% stocks in established companies
- 80% bonds, 20% ETFs or stocks in large companies
- 100% bonds
Moderate or Balanced
Moderate asset allocations can vary widely since they can be anywhere in the range between conservative and aggressive. Examples include:
- 10% cash equivalents, 10% international stocks, 25% large-cap stocks and 55% bonds
- 10% cash equivalents, 30% bonds and 60% stocks, including emerging companies
- 50% stocks, 50% bonds
Examples of aggressive portfolios include those where the focus is mostly on more volatile stocks:
- 15% cash equivalents or bonds, 30% ETFs or large-cap stocks and 55% in other stocks, including small and international companies
- 5% cash equivalents, 10% real estate, 85% stocks
- 100% stocks