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Asset Allocation
Asset Allocation
If an investor plans to have an investment for a long period of time, his or her portfolio
should be made mostly of stocks. Investors who are quite active but want to invest for
relatively short time spans should diversify their portfolios by including different kinds of
assets.
That is why, the concept of asset allocation was developed. Asset allocation is an
investment portfolio technique that aims to balance risk and create diversification by dividing
assets among major categories such as bonds, stocks, real estate, cash, mutual funds, pension
funds, bank deposits. Each asset class has different levels of return and risk, so each will
behave differently over time. When one asset is increasing in value, another may be
decreasing or not increasing as much.
Asset allocation
Bonds
Bank
Stocks
deposits
Asset Real
Deriva-
allocation estate
tives
Pension
Cash
funds
Mutual
funds
Stocks
Derivatives
Pension funds
Real estate
Corporate bonds
RISK
Mutual funds
Bank deposits
Government bonds
T-Bills
LOW
HIGH
It is not simple to decide whether to invest in stocks, mutual funds or low risk
instruments. The ideal asset allocation differs based on the risk tolerance of the investor. For
example, a young manager might have an asset allocation of 85% equity, 15% fixed income,
while a retiree would be more likely to have 85% in fixed income and 15% equities.
In addition, when deciding your most suitable asset allocation, you should take into account:
your age, how much time you have to increase your investments
the capital to invest
future capital needs
your personality and risk tolerance
1. In order to help determine which asset classes and subclasses are optimal for your
portfolio, match them with the following definitions: international securities, mid-
cap stocks, emerging market securities, money market securities, real-estate
investment trusts, large-cap stocks, fixed-income securities, small-cap stocks
Task
Choose your own ideal asset allocation.
What would you include in your own portfolio and why?
Decide the ratio risk/return for each item in your own portfolio.
Which asset allocation strategy would you choose?