Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment time frame.
Age and Investment Time Frame
Clients age and investment time frame have strong influences on investment choices. A younger investor with a longer investment timeframe may feel more comfortable taking on a more riskier or volatile investment because they can look beyond the immediate periods of slow economic growth and the inevitable ups and downs of the stock market. Likewise, an investor approaching retirement would probably take on less risk because they have a shorter investment time frame and therefore want to avoid the potential short-term market movements.
Risk tolerance is the amount of risk that an investor is comfortable taking or the degree of uncertainty that an investor is able to handle. When it comes to investing, risk and reward are inextricably linked. All investments involve some degree of risk, it is essential that investors understand this, at Berkeley Private Wealth we have access to independent chartered financial advisers to assist our investors.
Why asset allocation is so important
When different asset classes are included in a portfolio, investment returns will move up and down depending on the varying market conditions. Experienced investors use asset allocation as a way to diversify investments held within a portfolio. Spreading money among various investments ensures not all of them will go up or down at the same time. So, by investing in more than one asset category, the risk is spread making the portfolio's overall investment returns less volatile. In addition, asset allocation is important because it has a major impact on investors financial goals. If enough risk is not included within an investors portfolio, the investments may not earn a large enough return to meet the investor's target. For example, if an investor has 40 or 50 years until they retire, then most financial experts agree that they should have some exposure to equities within their portfolio. On the other hand, a portfolio heavily weighted to equities may be inappropriate if the investor is only five years from retirement. Determining the appropriate asset allocation model for a financial goal is a complicated task. Many believe that determining the asset allocation is the most important decision with respect to one's investments. At Berkeley Private Wealth, we have access to award-winning, highly experienced discretionary fund managers who deal with asset allocation amongst other things for our clients.
With a vast array of investment products; equities, bonds, funds and cash are only a fraction of the total investment products available to investors. Even within these particular asset classes, there are many subgroups and even derivatives of these groups, which also consists of subgroups. The three asset classes below have some basic characteristics:
Also known as stocks, have historically, the greatest risk and highest returns among the three major asset classes. As an asset class, equities offer the greatest potential for capital growth. However, the volatility of equities can make them a very risky investment in the short term, but investors who are able to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.
Government Bonds, or Gilts as they are known in the UK, are generally less volatile than equities but offer more modest returns. As a result, an investor approaching a financial goal or retirement age might increase their bond holdings relative to their equity holdings, because the reduced risk of holding more bonds would be attractive to the investor despite the lower growth potential. There are other types of bonds that are linked to corporate debt and these can offer higher returns than government debt, but the associated risk is usually higher as risk and reward are inextricably linked.
Cash as well as cash equivalents, such as savings deposits, certificates of deposit, treasury bills, money market deposit accounts and money market funds are the safest investments but offer the lowest return of the three major asset categories. The principal concern for investors investing in cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time.