Asset Allocation and the need to Rebalance Portfolio
Allocating assets means the division of one's investments across different existing assets in the form of bonds, stocks, and cash. It is of course a personal decision for anyone to allocate their assets, the type of asset allocation that works for you is dependent on the one you deem fit, based on how long you have made investment and your ability to tolerate risk. Before you begin to diversify or allocate your assets, there are two major factors to take into consideration;
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The first is the time horizon, which is the number of months, and years required for this investment to grow and begin to yield the expected financial return. While investors who have a longer time horizon will feel more comfortable with getting engaged in more volatile investments, those with a shorter time horizon will prefer to work with a lesser risk.
The second important point of consideration is risk tolerance, which is the ability of the investor or willingness to lose some of your original investment in turn for a potentially greater return.
Diversification is having your money/ asset spread across different forms of investment to help reduce the risk involved. One major reason why people choose to diversify their income is that, when one investment is performing poorly, the other is doing well.
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Some groups of investors find it easier to diversify through the ownership of mutual funds. Mutual funds is a company that gathers money from different investors and invests the money in the form of stocks, bonds, and other forms of financial products. With the existence of mutual funds, it has become possible for investors to own very small portions of different types of investment.
However, not all types of mutual funds will make you diversified as some mutual funds will not necessarily provide diversification especially if their focus is only on one industry sector, when this is the case, you may have to invest in several types of mutual funds to achieve the goal of diversification. This means you will need to pay additional expenses and charges which will reduce the return expected on investments, so before you diversify your portfolio, you need to think about the cost about the expected profit.
There is no right formula for asset allocation but smart investors believe that it is one of the most important financial decisions that could ever be made. A good asset allocation is different for individuals based on different factors like; age, risk appetite, and financial targets.
Some professionals believe however that the idea needs to be revised, particularly after studying the poor performance of bonds in recent years.
Financial advisors in terms of age-based asset allocation advise that the age of an investor from 100 to determine the percentage of stock investment.
It is generally believed that, the younger and farther you are from needing access to capital, the more you need to invest in stocks.
Investors also engage in rebalancing, which is something investors do to bring their portfolio back to its original asset. Rebalancing is highly required for investors because after some time, some investments would automatically grow faster than others and rebalancing will help ensure that the portfolio would not overweight a particular asset category. There are majorly three ways to have your portfolio balanced;
Through the purchase of new investments for underweighted asset categories.
The sale of investments in areas where holdings are overweighted and proceeds used to buy investments for underweighted assets.
If you plan to consistently add to your investments, you can choose to alter your contributions so you have more going into the category of underweighted assets until your portfolio gets back to normal.
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