Revisiting Financial Resolutions: Asset Allocation

28 May

Continuing on with our revisit of our earlier blog post “Get Financially Sorted in 2024 with These Steps”, we are looking at the integral role of appropriate Asset Allocation in achieving your financial resolutions, particularly the importance of Strategic Asset Allocation and Portfolio Rebalancing.

Asset Allocation

Asset allocation refers to the division of an investor’s portfolio into different asset-classes. Generally, the main asset-classes we refer to are:

· Cash (i.e. Bank Deposits);

· Fixed Interest (i.e. Government Bonds, Corporate Bonds or Credit Funds);

· Shares or equities (i.e. Australian Listed Shares, International Shares); and

· Property.

The above asset-classes can be segregated into what we call ‘defensive assets’ and ‘growth assets’. Cash and Fixed Interest are ‘defensive assets’, which means they are often used to defend your investment from losses, as there is typically very low to low risk of the investment losing its initial value, over the short-term. Conversely, Shares and Property are ‘growth assets’, as these investments have the intent to grow your initial investment, though have a medium to high risk of losing some of its initial value, over the short-term. We further explored the differences of these asset-classes in our earlier blog post “How Much Risk are You Willing to Take?”.

Appropriate Asset Allocation

Most of us have heard the colloquium “don’t put all your eggs in one basket” which summarises the need for diversifying your money (i.e. eggs) over different asset-classes (i.e. baskets) in an investment portfolio. This means a good investment portfolio should allocate investments between defensive and growth assets, but the question arises what ratio should be in defensive versus growth?

n order to determine an appropriate asset allocation, typically this is addressed according to your individual needs and circumstances after answering a number of basic, yet comprehensive, questions with a qualified financial planner. This will take into account your risk tolerance and investment time-frame.

For example, a 30-year-old who is accumulating superannuation for their retirement at age 60 may have a higher percentage of their investments allocated to growth assets, compared to a 70-year retiree who is drawing a weekly payment from their account-based pension.

Portfolio Rebalancing

A crucial aspect of having an investment portfolio is ensuring that the appropriate asset allocation you initially set-up has not, and does not deviate, over the long-run. Deviation from the initial asset allocation is a normal occurrence, as often differing asset-classes are uncorrelated and therefore can perform very differently from one another on a daily-basis.

This is where Portfolio Rebalancing as an investment strategy is critical. If, over time, your ‘eggs’ move from one ‘basket’ to another, then we utilise Portfolio Rebalancing to even them back out, and ensure that you aren’t over-exposing yourself in any one basket.

This involves the process of buying or selling assets in a portfolio to maintain the original appropriate asset allocation.

or example, if the appropriate asset allocation for a super-accumulator investor is 80% Shares and 20% Cash, but Shares have performed well during a given period, the portfolios weighting of the Shares might increase to 90%. In this example, you are taking on additional risk, which is outside your individual needs and circumstances. To correct this, a Portfolio Rebalance would sell some Shares down to Cash, to get the portfolio back to the appropriate asset allocation of 80/20.

While there is no hard and fast rule as to when to perform a Portfolio Rebalance, as stated in our earlier blog post, rebalancing annually is a good approach, as this will ensure that you are not overreactive to the normal volatility of the asset-class, whilst also ensuring that you do not deviate from your appropriate asset allocation over the long-run.

If you need assistance identifying, implementing and maintaining an Appropriate Asset Allocation catered to your individual goals, make a time for a meeting with us or continue following our Managed Money Blog posts to stay up-to-date.