Understanding this will help you find investment strategies that fit your personality. Once you understand the different asset classes available in the market, you will be able to manage your portfolio by allocating your investments into different asset classes that suit your needs.
Here is a guide to asset allocation for beginners who are keen to manage their own portfolio.
What is asset allocation?
Asset allocation is the process of dividing your investment portfolio into various asset classes to minimise your investment risk. This is because the risks are diversified across these different asset classes. Historically, the returns of different asset classes such as the stock market, bond market and cash, do not move in unison.
Establishing your asset allocation is a dynamic process that is constantly ongoing and it should reflect your financial goals, cashflow, risk tolerance and time horizon at any point in time.
Here are 5 strategies you can deploy to manage your portfolio.
1) Strategic Asset Allocation (SAA)
Strategic Asset Allocation (SAA) follows a certain policy mix by looking into the proportional combination of different asset classes based on their expected returns. By taking into account your risk tolerance and investment timeframe, you can set your target for the different asset classes and rebalance your portfolio every now and then.
The SAA strategy helps investors to diversify and cut back on their risks. For example, the stock market has a historical average return of 10% per year while bonds have historical average return of 5% per year. If this holds true, your portfolio of 50% in stocks and 50% in bonds, would generate an average return of 7.5% per year.
2) Constant-Weighting Asset Allocation
While SAA follows a buy-and-hold strategy with occasional rebalancing done, preferably once or twice a year, Constant-Weighting Asset Allocation will involve a proactive rebalancing of your portfolio. This is because the asset classes invested will move in value whenever prices change.
For example, this is your asset portfolio at the beginning of the year,
This means that your portfolio consists of stocks (50%), bonds (25%) and cash (25%). However, by the middle of the year, your asset portfolio will change if the stock market increased by 10%, bond market declined by 10% and cash remained stable.
Your asset portfolio at middle of the year,
This would mean your portfolio would now consist of stocks (53.7%), bonds (22%) and cash (24.4%).
In this scenario, a Constant-Weighting Asset Allocation strategy involves selling your stocks and buying into the bond market to maintain the same asset allocation. There are no hard-and-fast rules to determine when you should rebalance your portfolio, but this strategy helps investors to buy into assets when prices are low. The downside to this strategy is that investors might miss out on the bull run of an asset class.
3) Tactical Asset Allocation
Unlike SAA, Tactical Asset Allocation gives investors the flexibility to engage in short-term and tactical deviation from the targeted allocation. This flexibility incorporates the market-timing component to portfolio management, which might be more complex for beginners but it allows investors to participate in a market environment that is more conducive and favourable to a certain asset class.
4) Insured Asset Allocation
Investors who are averse to risk would find that Insured Asset Allocation is one of the ideal strategies to adopt in their asset allocation planning.
It involves setting a base asset value from which the portfolio should not drop below. As long as the return is above the base value, investors will exercise their own active investment management, relying on various strategies with the aim to increase their portfolio’s value as much as possible. However, if the value drops below the base value, investors will avoid risky assets and tap on risk-free assets until the base value is fixed.
This helps investors to establish a guaranteed floor level to the risks undertaken in investing. For example, a retiree that wants to maintain a certain minimum standard of living may find an insured asset allocation strategy to suit his or her needs. The downside to this strategy is that it does not provide any guidance for investors to grow his or her portfolio.
5) Dynamic Asset Allocation
Dynamic Asset Allocation is another active investment strategy that requires investors to actively adjust their mix of asset as the market rises and falls. There is also the need to keep track of the economic development.
With this strategy, investors will sell assets that declines and buy into assets that increases.
This makes Dynamic Asset Allocation the exact opposite of the constant-weighting strategy. With this strategy, it relies on the investors’ ability and judgement of the market behaviour as compared to relying on maintaining a targeted mix of assets.
Bottomline: Focus on what you can control
Asset allocation can be either an active or passive investment strategy depending on your preference. However, regardless of the strategies adopted, it is important for you to focus on what you can control – cashflow, financial goals, risk tolerance and time horizon.
These asset allocation strategies can only offer us a guideline on how to react to the market movement. It would however be futile for investors to try to perfectly-time the market. It is more important to focus on what you can control and plan your investment strategies by mitigating the downside risks with a diversification strategy that suits you.
Billy is passionate about the capital market and believes in investing for the long haul. Prior to this, he was an economist at RHB Investment Bank, covering Thailand and Philippines market. He also worked as a financial journalist at The Edge Malaysia and has experience working with an asset management firm. Aside from the capital market, Billy loves a good conversation over a cup of coffee, is a fitness enthusiast and a tech geek.