Understanding asset allocation is crucial to achieving your investment and retirement goals. In this blog, La Ferla Group will explain what it is, and break down a few common asset allocation models as an introduction for new investors.
What is Asset Allocation?
Defining “Asset Classes”
Asset classes are a key component of asset allocation, so we will discuss them first. They are investment categories that are grouped based on common characteristics.
For the purposes of this blog, we will focus on three main asset classes:
- Equities, also known as stocks
- Fixed income, also known as bonds
- Cash equivalents, also known as money market instruments
Defining “Asset Allocation”
Simply put, asset allocation is an investment principle intended to balance risk and reward based on an investor’s individual goals. This is often (but not necessarily always) done by investing money in several different asset classes, rather than just one.
How do you Determine where to Allocate?
Determining where to allocate your money is based on your individual financial situation.
This often takes into consideration the following:
- Goals. What are you seeking to achieve from your investments? Long-term wealth, steady income or a combination of the two?
- Risk tolerance. Are you willing and able to make aggressive investments that are volatile, or is it better to stay relatively conservative?
- Investment horizon. How long do you plan on holding onto your investments?
These will all be determined based on your age, income, net worth and more. Since these factors vary greatly from person to person, it’s recommended that you consult with a Certified Financial Planner™.
4 Common Asset Allocation Models
Based on your goals, you may be advised to invest according to one of the following common asset allocation models.
Note: these are not the only asset allocation models in existence, but will serve as a helpful introduction for new investors.
1. Preservation of Capital
One of the most conservative asset allocation models is known as “preservation of capital.” You may consider investing according to this model if the following reflects your goals:
- You do not want to undertake high risk investments
- You would like to liquidate your investments relatively soon
Cash and cash equivalents are often wise choices to invest in according to this model.
2. Income-Oriented
For investors who wish to generate a relatively steady income without undertaking a large amount of risk, the income-oriented model may be recommended. It often allocates money to fixed income investments and moderate risk equities.
Investors nearing retirement may be advised to follow the income-oriented model, because the steady income it generates will aid them after they’ve stopped working.
3. Growth-Oriented
Growth-oriented investments are high risk, high reward. They are often comprised of aggressive equities that represent higher volatility than the broader U.S. equity market.
This model is intended for younger people who are in the early of stages of their careers, attempting to build long-term wealth.
4. Balanced
The balanced model is sort of a halfway point between income-oriented and growth-oriented investments. Investing according to the balanced model does not necessarily favor either equity or fixed income investments, but whatever mixture of asset classes maximizes performance.
Remember, there is no one-size-fits-all investment strategy that will work for everyone. Based on your situation, it may be favorable to utilize a few different asset allocation models. That’s why it’s recommended that you meet with a Certified Financial Planner™ to truly determine what’s best for you.
