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How diversified asset allocation can help protect your future

19 December 2022

4-minute read

Plan Well Feature Healthy Finances

Diversified asset allocation is an essential component of a sound investment portfolio. (Credit: Shutterstock)

Determining the right mix of assets can seem intimidating at first. From bank products to mutual funds, stocks and bonds, each asset class carries its own risk-and-return profile. But seasoned investors know how to minimise the risk with diversified asset allocation. This process requires diversification across different asset classes to balance risk and reward.

Investing in assets like real estate, stocks and bonds don't generate a guaranteed return. Therefore, many beginner investors tap financial experts to help them diversify and determine the proper asset allocation. The exact mix will depend on factors such as risk tolerance, goals and time horizon.

Here's how asset allocation works to build a sound investment portfolio amid ever-changing market conditions.

Choosing an investment mix

Real estate, venture capital, commodities, hedge funds, art and cryptocurrencies are often referred to as alternative assets. (Credit: Shutterstock)

You may have heard the metaphor, "Don't put all your eggs in one basket". That advice can be applied to investing. You shouldn't put your entire investment portfolio in stocks, for example.

Instead, you should diversify, a strategy where you spread money among different asset classes – or categories of investments – such as stocks, bonds, cash or real estate. By diversifying across different assets, you reduce overall risk. If one investment does poorly, the other investments can make up for those losses. The correlation between asset classes varies depending on the assets.

Investing in different asset categories may lessen the impact of economic events and market fluctuations on the portfolio. For example, adding bonds to your portfolio provides an excellent diversification benefit as the correlation (over long periods) is negative – meaning if stocks go up, bonds go down and vice versa. Cash is an asset with zero correlation to traditional asset classes, so it is a must in most portfolios.

However, there are exceptions. For example, government bonds typically do well when the economy is weakening. But current high inflation rates result in declines in both bonds and stocks.

The most popular asset classes for retail investors are stocks or equities, bonds, real estate and cash or cash equivalents like money market funds. All of these come with different levels of risk and potential for reward.

For example, while stocks tend to have the highest return potential, they also carry the highest risk. Cash has the lowest return potential but the least amount of short-term risk, although cash loses its value in an inflationary economy. Finally, bonds fall somewhere in between stocks and cash on the spectrum of risk versus reward.

Anything outside these three categories – including real estate, venture capital, commodities, hedge funds, art and cryptocurrencies – can be referred to as alternative assets.

Now, how do you determine the right asset allocation for you?

Asset allocation is a personal decision

Financial experts refer to asset allocation as a "personal decision." The mix of investment choices depends on an individual's overall goals, risk tolerance and time horizon.

Risk tolerance refers to how much risk you're comfortable taking when investing. A conservative investor may want mostly low-risk investments and more secure assets like bonds. An individual with a high risk tolerance can handle the market volatility that comes with higher-risk assets, such as stocks.

The time horizon – the amount of time one holds on to an investment – depends on the financial goal and informs risk tolerance. For example, young investors with a 20 to 30-year time horizon can make room for higher-risk portfolios because they have the time to deal with market fluctuations. On the other hand, saving to buy a house in the next five years calls for low-risk assets because of the short time horizon.

Many factors must be considered for successful diversification and asset allocation and working with a consultant can simplify this for you.

Check the balance of your investments

A specific financial goal will make investment decisions easier. (Credit: Shutterstock)

There are many ways to build a diversified portfolio. Invest in an exchange-traded fund, which can contain stocks, commodities or bonds. Select an index fund to invest in stocks across various industries. Buy bonds from different issuers, such as private and public corporations or the government. Put money in commodities and real estate investment trusts (REITs). Talk to your financial advisor about your options.

"The key is to identify investments in segments of each asset category that may perform differently under different market conditions," the U.S. Securities and Exchange Commission shares on its website.

Once you start investing, review your portfolio regularly. Perform a meticulous "rebalancing" to ensure the allocations align with your financial goals, time horizon and risk tolerance. You can rebalance at least once a year – or quarterly, in times of uncertainty or extreme volatility.

Although there are no guarantees, diversification and proper asset allocation can provide you with potentially competitive returns while protecting you against huge losses. But if you're still unsure about the risks, try savings insurance that guarantees future protection and an income stream. Talk to your local AIA representative to find the solution that works for you.

A "scarcity mindset" may be preventing you from achieving goals. In this episode of AIA Voices, finance experts Anna Haotanto and Lachlan Campbell, with AIA Ambassador Nico Bolzico, explain how this way of thinking prevents financial wellness. Watch as they share tips to put you on the path to financial freedom.

AIA Voices is a community of influential and educational voices from around Asia to talk about life, health and wellness. A platform to educate, motivate and inspire people to make positive behavioural changes on their health and wellness journey. Providing an opportunity for communities across Asia to connect, collaborate, and learn from each other. Designed to drive AIA One Billion, our ambition to engage a billion people to live Healthier, Longer, Better Lives by 2030.

References:

Investor.gov. Beginners' Guide to Asset Allocation, Diversification, and Rebalancing. [online] [Accessed on 31 August 2022] 

Nasdaq. 2015. Allocation Vs. Diversification. [online] [Accessed on 12 August 2022] 

Disclaimer:

This is general information only and is not intended as financial, medical, health, nutritional or other advice. You should obtain professional advice from a financial adviser, or medical or health practitioner in relation to your own personal circumstances.