Once you’ve decided on your investment objectives and goals, you need to decide on what mixture of asset classes will help you achieve them at a risk level you’re comfortable with. The asset allocation decision is an important one because history has shown that it is this, as opposed to the specific investment selection, that produces the majority of returns. Furthermore, allocating your money across a range of assets provides you with diversification benefits which includes the reduction of risk.
What is asset allocation?
Asset allocation is the process of allocating your money to key asset classes. These include:
| ||Growth||Income (yield)
|Fixed Interest (e.g. bonds)||Increase in bond value||Coupon
|Property||Increase in property value||Rent
|Equities (shares)||Increase in share price||Dividends
The table above shows where returns from each asset class are derived from.
In normal circumstances, the proportion of an investor’s portfolio which is allocated to cash and fixed interest securities would decrease as you move up the risk scale, whilst the proportion allocated to equities would increase. An investor’s objective may influence their portfolio asset allocation due to the prevailing characteristics of different asset classes at the time of portfolio construction. For example, if an investor with an income objective were constructing a portfolio at a time when yields (income paid) on fixed interest securities were relatively low, whilst yields on equities were relatively high, they may choose to have less exposure to fixed interest and more exposure to equities. The asset allocation of an investment portfolio need not be set in stone; it can be altered over time to meet changing objectives, risk tolerances, and market conditions.
Below are the investor risk categories described earlier with guidance on the asset allocation that could apply to a portfolio at each level:
- Cautious: typically, only a small amount of riskier assets would be included in a portfolio. A typical asset allocation would be mostly invested in fixed interest and cash, with a small element – up to about one-third – in equities and property, which can boost longer term returns but are associated with more risk.
- Cautious-Moderate: a typical portfolio will have slightly more than half invested in fixed interest investments and cash. The other, smaller half of the portfolio will be invested in equities and property.
- Moderate: typically,a moderate portfolio will have a slightly higher proportion of equities and property compared to fixed interest and cash
- Moderate-Adventurous: a typical portfolio will be invested mainly in equities but with up to around one-third invested into other assets to provide a reasonable level of diversification.
- Adventurous: a typical Adventurous investor will have a significant proportion of their investments in equities, with a small exposure to other asset classes.
The above is purely for guidance purposes only and should not be construed as investment advice. Your asset allocation will be affected by a range of factors specific to your personal circumstances and the descriptions above take no account of these.