Phrases like “don’t put all the eggs in one basket” or “diversify the portfolio” capture the essence of asset allocation. This guide explains what asset allocation means and why it plays a critical role in building a successful investment strategy.
What Is Asset Allocation?
Asset allocation is the strategy of dividing investment capital among different asset classes—such as stocks, bonds, and cash—to balance risk and return. Much like planning a nutritious meal, a well-diversified portfolio seeks the right mix of ingredients to support long-term financial health.
The chosen mix should reflect an investor’s objectives, risk tolerance, and investment horizon.
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Why Is Asset Allocation Important?
Asset allocation helps manage risk. Different asset classes behave differently under various market conditions. For instance, equities offer higher return potential but are more volatile, while bonds are generally more stable but yield lower returns. A diversified allocation reduces the likelihood that all investments move in the same direction at the same time. This mix can help smooth out performance and improve the chances of meeting long-term goals.
Common Asset Classes
These are the common asset classes in investors’ portfolios:
- Stocks (Equities): Higher volatility, greater growth potential
- Bonds (Fixed Income): Lower volatility, consistent income
- Cash or Cash Equivalents (T-bills, Money market funds): Minimal risk, limited growth
- Other Assets: private equity, private mortgages, venture funds, etc.
What is a balanced portfolio/fund?
A balanced fund is an all-in-one investment that includes a mix of stocks and bonds to help balance growth and stability. It’s a simple way to stay diversified without having to choose and manage different investments. A typical balanced fund can invest about 60% in stocks for growth and 40% in bonds for stability. It’s designed for investors who want a steady, long-term approach and prefer to let professionals manage the mix of investments.
Embark RESP portfolios are examples of balanced funds, where the asset mix is based on the target date. Purchasing just one share of the fund would immediately diversify the investment across asset classes, and further into different sectors as well as geographical locations. This is a good example of an investment designed to minimize risk and provide consistent returns.
How does this translate to an individual investor? Well, an investor can either purchase a fund that immediately provides diversification benefits or construct their own portfolio with the diversified asset classes.
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What Affects the Asset Allocation decision?
Several personal and financial factors drive asset allocation decisions:
- Age: Younger investors typically have a longer time horizon and may be more comfortable with risk.
- Investment Goals: Short-term objectives (e.g., saving for a home) often require investing in less volatile assets, while long-term goals (e.g., retirement) may accommodate more growth-oriented investments.
- Risk Tolerance: Investors vary in how they respond to market volatility. A conservative allocation may be suitable for those less comfortable with short-term losses.
- How Does It Work in Real Life?
When equity markets decline, a portfolio heavily weighted in stocks may experience sharp losses. However, a diversified portfolio that includes bonds and cash equivalents – assets that may hold steady or even increase in value during market downturns – can soften the impact.
This interplay among asset classes is what makes allocation a vital tool for managing risk.
Rebalancing: Keeping the Portfolio in Shape
Over time, certain asset classes may outperform others and alter the original allocation. For example, a portfolio intended to be 60% stocks could drift to 80% after a strong equity rally. Rebalancing involves adjusting holdings to realign the portfolio with its intended strategy and is a part of a disciplined investment process.
Sample Asset Allocation by Age (Just a Guideline!)
| Age Range | Stocks | Bonds | Cash |
| 20s–30s | 80% | 15% | 5% |
| 40s–50s | 60% | 30% | 10% |
| 60s+ | 40% | 50% | 10% |
* These percentages are only illustrative. Each individual’s unique circumstances should guide the actual allocation.
Final Thoughts
Asset allocation serves as the foundation for long-term investing. A well-constructed mix of assets can offer a smoother journey toward financial goals, even in uncertain markets. It is not about predicting what will happen next—but about being prepared for whatever comes.
Senior Analyst
Sandeep Suresh is a Senior Analyst, Investments at Embark. He holds an MBA in Finance and is currently pursuing his CFA Charter. In his free time, he enjoys breaking down complex financial data into clear and digestible insights.
