Investment Strategies - Asset Allocation
Asset Allocation refers to the process of apportioning assets available for investment among various investment classes. Asset Allocation is important because nearly 90% of long-term performance is determined by the asset allocation of the portfolio. These investment classes include the various investment types below:
- Money Market Securities
- Fixed Income Securities
- Common Stock
- International Investments
- Real Estate
- Collectibles (generally a small portion of your portfolio, or non-existent)
There are two different strategies of asset allocation; Passive and Active.
Passive Asset Allocation:
A passive asset allocation begins by setting specific percentages for each asset class. These percentages for a passive strategy should be maintained over time. To achieve this goal, the portfolio will require rebalancing every six months or so. Note: this will cause transaction costs and taxes could be incurred.
For example, an investor may decide to have a portfolio of 50% equities and 50% fixed-income securities. Over time, the ratio of common stock and fixed income securities will deviate from the original allocation because of gains, losses and income. Therefore, to maintain the original asset allocation (50/50), assets from one class will have to be sold and be reinvested in the other asset class. This is called rebalancing.
Active Asset Allocation:
Active asset allocation refers to changing the mix of investment classes based on changes in market conditions. This strategy is often called market timing and is based on the belief that investors can increase returns over time by switching among asset classes. Market timers will analyze the different asset classes to determine which ones are undervalued and which ones are overvalued. The overvalued securities will be sold in expectations of falling prices. Undervalued securities will be purchased in anticipation of rising values.
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