Asset allocation refers to the proportions of their portfolios that investors or asset managers place in the main asset classes of equities, debt, property, cash and others. Allocation decisions are based on a variety of individual investor characteristics like risk tolerance but is also strongly influenced by the prevailing investment-market conditions.
Asset allocation is an important influence on portfolio returns because different asset-class returns have historically moved up and down at different rates and times to each other. Spreading the portfolio across asset classes therefore reduces the risk of major losses if one class, such as stocks, suddenly falls precipitously. Conservative investors usually prefer a balanced asset allocation like a 40% stocks, 40% bonds (usually Treasury bonds or Treasury notes) and 20% cash while the more risk-tolerant might prefer to to allocate more than half to stocks. Asset allocation can change over the portfolio's time horizon as conditions for different asset classes alter but needs to be rebalanced by returning to the original allocation if it becomes too weighted on one class.
Some analysts believe that asset allocation is a more important determinant of overall portfolio returns than the individual investment decisions within each class.Consequently, large investment pools of institutional investors such as pension funds or endowments often hire asset managers like BlackRock and Piper Jaffray to determine their fund's broader allocation strategy. Asset managers working on behalf of institutional pools are also called investment managers or money managers.
The recent sharp decline in global stock markets have led many investors and managers to reconsider the wisdom of keeping their portfolio overweight (more than 50%) equities in light of recent studies showing that a 50/50 balance of equities to debt yields only slightly below and 80/20 allocation (640% compared to 684% over 21 years) with less volatility. However, some commentators have pointed out that timing is key, since between August and October 2008 stocks fell 25% while bonds dropped just 1%. This effect can reduced somewhat by investing in stocks that pay good dividends and so behave more like debt than equities, while the more aggressive can invest a reduced stock portfolio on higher-risk, higher-return equities.
- ↑ Beginners' Guide to Asset Allocation, Diversification, and Rebalancing. SEC.
- ↑ Asset Allocation. Investopedia - Forbes Digital.
- ↑ Is Your Portfolio Too Stock-Heavy?. Motley Fool.