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What is asset allocation?

Put simply, asset allocation is one of the most, if not the most, important decisions anyone makes when investing. The process of selecting individual stocks or asset classes is secondary only to the proportion of those asset classes within the portfolio, both central tenets of an asset allocation strategy.

We all invest, principally, to protect and grow our wealth. It is through effective asset allocation that successful investors achieve the results they do. Any wealth manager worth their salt will have a highly experienced asset allocation team who can be trusted with such a core investment decision. But, what exactly do we mean by asset allocation?

Asset allocation defined

Asset allocation is the way in which an investment strategy is implemented. You can decide on an investment strategy that balances risk and reward, but all this does is inform the assets you choose to buy to make up an investment portfolio. Then, there is a process of adjusting the proportion of each asset in the portfolio that achieves that balance.

The proportion of each asset class that makes up a portfolio will, fundamentally, be defined by the individual’s investment goals, risk tolerance and time horizon.

On the one hand, someone who needs their savings in the next year or two might choose to have a conservative asset allocation, made up of things like cash and short-term bonds. On the other, someone saving for a retirement that is decades away is more likely to have a high equity allocation.

Risk tolerance should also be considered when deciding on asset allocation – investors need to feel comfortable with the movements they see in their portfolio’s performance. The types of assets that make up a portfolio will, generally, determine how much movement an investor sees.

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What are assets?

Anything you hold as an investment is known as an asset. This broad definition includes anything from a property holding to stocks in an oil company or even Chinese currency. The three main asset classes are equities, fixed-income, and cash (or equivalents). Each of these strikes a different level of risk and return and, as a result, will behave differently over time.

At Moneyfarm, we rely on the use of exchange-traded funds (ETFs) to build up our asset allocation; these are passive tracking instruments. Most ETFs are index funds, meaning they are made up of the same securities, in the same proportions, as an index like the FTSE 100. You buy into that ETF and your performance will track the performance of that market. We use ETFs across a range of markets to give you a diversified portfolio.

The benefits of effective asset allocation

An effective asset allocation strategy enables you to manage the risk in your portfolio. Asset classes rarely go up and down in sync with one another, so having exposure to a range of asset classes limits the risk impact of any one asset class.

Given the fundamental importance of the practice, it often pays to have an experienced, qualified professional take care of asset allocation on your behalf. Building an investment portfolio that is well balanced and effectively diversified can be an expensive and time-consuming thing to do alone.

At Moneyfarm, our team of asset allocation specialists assigns every investor with a portfolio that suits not only their goals but their risk tolerance and their time horizon. We monitor markets daily to ensure that our portfolios are made up of the right assets to provide positive returns to our clients. You can find out more about our investment strategy and what it could do for your savings here.

Photo by Nick Hillier on Unsplash

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