Nowadays successful investing can’t be made without smart allocation of assets. It is not a good idea to put everything in one bucket, people who have experience in investing prefer to spread their earnings in different assets such as long term stocks, bonds, real estate and so on.
Beginners in investing have to learn how to allocate assets properly because it is directly connected with reaching your investment goals.
The key factor in successful asset allocation is to control the difference between the risk you take and the money you invest in. If you are taking a huge risk than be ready for a generous reward but remember that risk is a risk and you can lose all the money you invested. That is why it is crucial to find the golden mean between risk and amount of profit.
The classification of assets
Let’s start with bases of investing before we move on to allocation. It is important to know the main types of assets. They are stocks, bonds, cash, and electronic money. When it comes directly to the selection of assets experienced investors consider two things: the amount of risk this asset has and the amount of profit it can give back.
Stocks are considered as one of the riskiest investments because they are not stable at all. According to the index of 500 stocks – S&P 500 the price of stocks ranging either up or down. However, history knows particular situations when stocks gave a hundred percents of return in long term period. Moreover, if we look at the situation over time we will find out that between 1928 and 2016 the average annual return was stable and equals 11%. You should form a portfolio and make good research to invest in stocks and after that just hope that they want to lose in value.
If you are looking for more safety asset to invest in you can pay your attention to bonds. But remember that you pay for this safety with less amount of profit. In that way, the annual return on government bonds in the same period between 1928 and 2016 was only 5%. Still, this sort of investment is perfect to keep your portfolio less risky and more measured.
The last type of investment is cash and electronic money. These types of investment are rapidly losing in value over time. This happens because of inflation, which means that goods cost more and more every coming year. So it is a pretty controversial decision just to save cash. On the other hand, it can be viewed as a short investment for the period when the market is falling or you simply don’t know where to invest. A useful tip is to keep some amount of cash in a portfolio to have fast access to them in case something happens. Speaking about electronic money it is important to pay your attention to cryptocurrency which is a popular investment nowadays among even wales of Wall Street.
Tips for proper allocation of your assets
Now let’s turn directly to allocation. We are going to cover only three types of assets mentioned below.
There is no straight guide on how to allocate assets properly but there are some rules which you can follow.
It is crucial to understand that when you are keeping your money is cash they only lose their value. Of course, if you don’t want to take risks at all you can turn everything in cash but different studies consider that products increase in price over the time so you won’t buy as much now as you could in the past for the same amount of cash.
At the same time, you can put all your dollars in stocks. It seems like a perfect decision because the average annual return ratio according to S&P 500 is 11%. But still, there are some nuances because this ratio is average for 80 years. If we look at stocks as a short term investment they can easily go down, like in 2008.
That is why it all comes to two things: your ability to balance a portfolio and your risk tolerance. If you are risky enough you can compose your portfolio mostly of stocks and spend less on cash and bonds. If you can’t stand the fact that the amount of money you invested reduces from time to time than the perfect option for you is a larger mix of bonds and cash than stocks. Also, remember to make a good research about stocks or bonds you are buying when balancing your portfolio or you can copy the portfolio of an already successful investor.
The way how to allocate assets properly also depends on time frames in which you want your money to make a return with profit. Because of that professional investors consider two time horizons: long time and short time investments. If you decide for yourself that you don’t need dollars you invest for 20 or more years than it will be a wise choice to balance your portfolio with assets which can make more profit but can be risky enough such as stocks. At the same time if you are planning to invest from 2 to 5 years long and then withdraw your investments it is better to take fewer risks and buy bonds or save cash. In conclusion, remember a famous quote of Warren Buffet, he was once asked: “Why doesn’t everyone just copy you?” Warren Buffett: ”Because nobody wants to get rich slow.”
Besides you can hire a financial planner. He can help you with the understanding of your risk tolerance and determination of time frames which satisfy you.
Keep up with the times
While creating the portfolio you have to keep an eye on today trends and you can’t let yourself stop watching the trends even when you already formed the portfolio. Over time your portfolio can become out of dates and you have to rebalance it from time to time. For example, in a particular period of time, your portfolio consists of 80% of stocks and they gave you a huge income. But you know that after that increase there can happen a huge dump. At this moment it is reasonable to rebalance your portfolio and leave only 50% of stocks and other 30% which you sold spend on bonds. However, be careful and remember about taxes which you have to pay while selling your stocks. For this operation, it is better to visit a tax advisor.
Attention! Nobody can fully guarantee that if you allocate assets properly you will 100% return your investments with gain. All types of investments carry some level of risk. You also should not exclude loss of your entire investment capital. If returns showed a positive interest in the past it doesn’t mean they will do this good now or in the future, however it works in the other way too. You need to work on yourself to keep calm in the highly volatile periods in the market.
Also, there is a tendency with bonds which can affect investors who make their portfolios mostly of bonds. If the interest rate is rising than bond prices are dumping and if the interest rate is falling than bonds prices are rising. Besides high yield bonds contain more risk because of interest rate risk, credit risk, liquidity risk, and inflation risk.