In my previous blog post, I talked about the importance of diversification in building a portfolio to target performance and reduce risk to help you reach your goals and tolerate volatility. Asset Allocation is another key ingredient for a successful investment strategy.
You can own stocks, bonds, real estate, commodities and several other categories and classes of assets so that some of your holdings zig while others zag. You choose what and how much to allocate to various categories to match your strategy, tolerance, time horizon, financial profile and to achieve a level of risk and return that helps you achieve your goals. One holding may go up when the stock market goes up, but other holdings may go down. That is a sign of good diversification and asset allocation. If everything you own goes up and down in value together all the time, you may not be diversified or have good asset allocation.
Another reason to allocate your funds to different assets is to capture new investment opportunities. You may have all U.S. stocks in your portfolio, but the U.S. only makes up just over half of the world stock market by capitalization and there are growing economies and companies all over the world that you may be missing. Having an allocation to international stocks has not worked in recent years, but that can change at any time. Owning some international stocks and bonds can not only help diversify your portfolio, but give you an opportunity to benefit from growing middle classes in Asia, Africa, the Middle East and Latin America and some of the world’s best known brands in Japan and Europe.
There is a trade-off between investment performance and risk. A highly tolerant person who has a long time horizon often owns more stocks because of the higher potential return and the time to ride out the volatility. Vice versa is also true. If you are risk adverse, you may want to own less stocks, all else being equal. Asset allocation helps you build out a portfolio where the holdings have different and perhaps opposing exposures to risks. Finding that balance that allows you to tolerate volatility and earn your target rate of return is one of the most important things we do at Skyline Advisors. Owning bonds is a tried and true way to offset stock market risk.
Stay tuned to my next blog post on The Role of Bonds in your Portfolio.