Don’t put all your eggs in one investment basket
All investment carries risk. When you make an investment, it can be impossible to say with any certainty what you’ll get back when you finally cash it in. Share prices fluctuate, interest rates vary and inflation creeps – or even at times runs – up on us. They all contribute to risk.
Some risk is essential if you want the potential to maximise your returns – safe investment is rarely the best performing. The trick is to tailor your risk to your circumstances.
So how do you manage risk? The answer is by asset allocation.
What is asset allocation?
Asset allocation is the process of determining which mix of assets to hold in your portfolio. Street vendors sell seemingly unrelated products – such as umbrellas and sunglasses. When it’s raining, it’s easy to sell umbrellas but harder to sell sunglasses. When it’s sunny, the reverse is true. By selling both items- in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.
Asset allocation works in the same way. By dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash, when a metaphorical rainy day comes along and puts a damper on cash, stocks and bonds can still deliver.
The major asset categories
Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money overall.
Stocks – Stocks have historically had the greatest risk and highest returns among the major asset categories. As an asset category, stocks are a portfolio’s “heavy hitter,” offering the greatest potential for growth. The volatility of stocks makes them a very risky investment in the short term, but investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.
Bonds – Bonds are less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings. However, certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk.
Cash – Cash and cash equivalents – such as savings deposits, certificates of deposit, treasury bills, money market deposit accounts, and money market funds – are the safest investments, but offer the lowest return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low.
Property – property investment is generally low risk, with predictable returns. It is traditionally regarded as an investment for incomes, although it can often now demonstrate attractive capital growth.
The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.
Determining the appropriate asset allocation model for you is a complicated task. Basically, you’re trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk you can live with.
When you start out, you might want mainly high risk investment, to maximise your capital growth – you’ll have time to invest again if things don’t work out. As you get closer to meeting your goal such as retirement, you’ll want less risk, and switch to slow and steady growth, by adjusting your mix of assets.
Some financial experts believe that determining your asset allocation is the most important decision that you’ll make with respect to your investments – that it’s even more important than the individual investments you buy.
That’s why it makes sense to get professional advice to help you determine your initial asset allocation and suggest adjustments for the future. You’ll be able to discuss your attitude to risk and your market timing, and use it to shape your asset allocation.
Call our investment professional to discuss how they can deliver the help you need.
The value of investments can go down as well as up and you may not get back the amount invested.