In our financial planning process at Marshall Financial Group, risk tolerance plays an important role. Because you have a variety of factors impacting your individual goals, how conservative or aggressive you want to be in your investments will be unique to you. Asset allocation is a strategy to balance investment risk versus potential reward.
What is asset allocation?
There is the classic saying, “Don’t put all your eggs in one basket.” This is essentially what asset allocation is. Rather than putting all of your money into one type of investment, assets are divided across stocks, bonds, cash and alternatives. Just like the saying, the idea behind asset allocation is that if your basket drops, you don’t lose all your eggs. Stocks might go down, but bonds could remain stable. Like the egg analogy, asset allocation helps manage investment risk within your comfort zone. Although asset allocation doesn’t guarantee against all investment loss, the goal is to reduce risk and potentially increase returns.
Why does asset allocation work?
The US Securities and Exchange Commission (SEC) writes that, “Historically, stocks, bonds, and cash have not moved up and down at the same time.” Factors that cause stocks or bonds to go down in value may cause the other to go up. However, they also note that asset allocation works in combination with your risk tolerance and time horizon.
How does asset allocation work with other investment strategies?
In 2021, financial advisor Brad Clough explained the basics of Dollar Cost Averaging, or investing periodically over time. “By continually contributing to the investment account, you are buying more shares when the market is low and less shares when the market is high assuming you keep investing the same dollar amount,” he writes. The array of investments that you purchase using this strategy would incorporate the asset allocation targets that best meet your risk tolerance and time horizon. If you are 30 and investing for retirement, you may be willing to take more risks perhaps, than if you are 50 and retirement seems very close.
In a follow up to his DCA blog post, Brad writes that when clients get closer to a goal, “they sometimes become less aggressive with their investments. During our client reviews, we continue to talk about goals and risk tolerance and have a conversation regarding progress toward your goals and any changes that might be appropriate.”
Asset allocation should also be considered within an asset class. This means that even with stocks, you should not have all your money invested in one stock. Depending on the market, different stocks (and even classes of stocks) can perform differently. While tech stocks might be down, construction and materials stocks might be up.
We also believe in rebalancing portfolios so that they reflect your goals, risk tolerance, and desired asset allocations. For example, if an investment is underperforming, that asset can be sold and the proceeds can be used to purchase an investment that might have a better potential in the future. (We explored this in our blog post on tax-loss harvesting.) As the SEC points out, “Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use would entail transaction fees or tax consequences.”
By reviewing your portfolio and investments, our advisors can determine when and if you should be rebalancing your portfolio. If you have any questions about your investments, don’t hesitate to reach out to our team.
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