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Asset Allocation

Updated: Aug 27, 2023

Let’s discuss a topic that’s responsible for approximately 90% of your success as an investor!

Friends meme on diversification

What is Asset Allocation?

Formal definition from Investopedia:

  • Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon.

Less formal definition from me:

  • Distribution of your money across various assets.

Why Does it Matter?

According to Vanguard, “extensive research has shown that, if you have a diversified portfolio, a whopping 88% of your experience (the volatility you encounter and the returns you earn) can be traced back to your asset allocation.”

In other words, this is critical. Let’s spend a minute on the following example of returns based on different asset allocation mixes between stocks and bonds:

At the extreme ends, you are choosing between a 100% stock portfolio with a 10% return, a worst year of -43%, and 26 out of 94 years experiencing a loss and a 100% bond portfolio with a 5% return, a worst year of -8%, and 14 out of 94 years experiencing a loss. These extremes are only further complicated by the number of options. We live in arguably the best time in history to be an investor due to the cheap or free cost to invest coupled with the seemingly endless number of options (e.g., real estate, crypto, crowdfunding). In other words the above only represents four basic portfolios, but there are countless permutations to develop your mix of assets and most importantly there is no correct answer.

How to Figure it Out?

Below is the overly simplistic way to look at this piece of the wealth puzzle:

  1. Learn: Asset types behave differently as indicated in the image above, so learn about different investments to determine what might be a good fit for you based on your goals, needs, and personality! As you learn, especially about newer investments, such as crypto, this doesn’t mean you should allocate 100% of your portfolio to it! Being diversified, or having a mix of assets, is helpful!

  2. Personalize it: This isn’t a situation where one-size-fits-all and you need to figure out what will work for your specific situation and personality. This is potentially further complicated if you are charting this walk to wealth with a partner who may have different views, but it’s critical to be on the same page about this one!

  3. Ask for Help: Professionals, including myself, exist for a reason. Ask for help! This can certainly be a DIY project, but it’s also one that’s critically important and easily overwhelming.

  4. Stay Consistent: Aside from never starting, one of the worst things you can do as an investor is constantly change your mind. Let’s go back to our previous example of the 100% stock portfolio for a moment. If a 40-50% decline is going to cause you to panic sell then it’s likely not the asset allocation for you!

  5. Sleep Well: Ultimately you can’t get wealthy without taking on some amount of risk, but you want to find an allocation that will also allow you to sleep at night!

Meme of sleeping well with the right asset allocation

Disclaimer: The information in this post is provided for your convenience only and is not intended to be treated as financial, investment, tax, or other advice. The information is intended to be educational and is not tailored to the investment needs of any specific individual.  It is also not intended to be relied upon as a forecast and is not an offer or solicitation to buy or sell any securities or to adopt any investment strategy.  The opinions expressed are those of the author.  Reliance upon the guidance and information in this presentation is at the sole discretion of the individual.

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