Asset allocation is an important investment decision that will impact your investment portfolio. As shown in Exhibit 1, asset allocation explains over 90 percent of the return and volatility in the return of your investment portfolio. Getting this decision right will set you on the path to achieving your long-term financial objectives.
Asset allocation is defined as the percentage of your portfolio invested in various asset classes such as stocks, bonds, alternative investments, and cash. There are two types of asset allocation decisions. Strategic asset allocation decisions are made for the long-term, in some cases measuring 3-10 years. Tactical asset allocation decisions are short-term in nature, reflecting either a risk or investment opportunity resulting from the recent mispricing of a specific asset or asset class.
The same asset allocation target does not apply to everyone. The asset allocation target may be different due to an individual’s risk tolerance, need for income, or unique circumstances. I serve as the Co-Chair for Comerica’s Investment Policy Committee (IPC) which is responsible for establishing the asset allocation recommendations for clients in Comerica’s Wealth Management division. The IPC provides seven asset allocation recommendations in recognition of the different circumstances that can impact our clients’ ability to take risk in their investment portfolio.
There are different approaches to determining the appropriate asset allocation target for you. Your advisor should be able to take you through the process of making this determination.
Consider these points when determining your asset allocation targets:
1) Make sure the asset allocation target you choose reflects your ability to live with fluctuations in the market value of your investments.
2) Once the asset allocation targets are set, make sure you and your advisor stick to those targets. Rebalancing your investment portfolio periodically back to the appropriate asset allocation target is very important.
3) Once a year, go through the process of determining the appropriate asset allocation target for your investment portfolio. There may have been changes in your personal circumstances that warrant a new asset allocation target. In addition, market conditions can change, which may cause you to revise the current asset allocation target for your investment portfolio.
Work closely with your advisor to determine the asset allocation target that meets your needs. It will be time well spent.