What is an asset allocation? It all depends on the right mix – this also applies to investments. When putting together their portfolios, many private investors attach great importance to the fact that risks and potential returns are as consistent as possible. How it works? With the so-called asset allocation. In this article, you will learn what asset allocation actually means, what it means and which methods of asset allocation are available. We also show the associated advantages and disadvantages.
The term “asset allocation” is made up of the English words for asset and allocation. “Assets” include both financial assets such as cash, investments or securities and tangible assets such as real estate. Allocation is generally understood to mean the allocation of resources to specific users or purposes. The asset allocation is thus defined as the allocation (or allocation) of assets. Further synonyms are asset allocation, asset allocation, asset structuring or portfolio structuring.
What is an asset allocation?
As a definition in the context of financial investments, asset allocation describes the distribution of capital across different asset classes. In other words, instead of putting everything on one card, investors invest their money in various financial instruments. The broadest possible spread should ensure that risk and return are largely balanced. To this end, financial strategists take advantage of the fact that the returns of different asset classes are not related and that each class carries a different level of risk. To understand this, you should first get an overview of the various asset classes.
What asset classes are there?
Investment or asset classes are groups of financial instruments with similar characteristics in terms of risk, earnings potential and performance. They can be roughly divided into deposits, securities, real estate and raw materials . Asset classes are mutually exclusive, comprehensive, and their returns are unrelated. The last criterion in particular is of crucial importance for asset allocation because it states that the return on one asset class can increase while the return on another class falls. Investors can take advantage of this property when composing their portfolio.
ASSET ALLOCATION AND CORRELATION
In order to benefit from the potential advantages of asset allocation, investors should know what interactions or correlations exist between individual asset classes. In the best case scenario, investors structure the portfolio in such a way that the losses of one asset class are offset by the gains of another. It basically shows that the money is invested in asset classes that correlate negatively – which means nothing other than that they behave in opposite directions. An example: In a crisis like the corona pandemic, the stock exchanges often crash or at least experience significant price fluctuations. Gold, on the other hand, has traditionally been seen as a safe haven, where many investors take refuge in times of crisis to protect their assets. While stock prices are falling.
How does an asset allocation with ETFs work?
One way of dividing assets across different asset classes is to invest in exchange-traded index funds, or ETFs for short . They are seen as a broadly diversified form of investment and are therefore ideal for diversifying your own portfolio. With various ETFs on stocks and bonds , but also with commodity or industry ETFs , you can diversify your portfolio as a whole for the widest possible risk diversification – on the other hand, you have the option of broader positioning within the respective asset class. Despite the broader diversification, however, you must always expect fluctuations in value and even losses when investing in ETFs.
What methods of asset allocation are there?
As a general rule, the portfolio structure should always correspond to personal investment goals. The selection of the asset classes is based on three central criteria: profitability, security and liquidity. These three competing goals are in the magic triangle of investmentshown. Before you put together your individual portfolio, you should first answer the following questions for yourself: What is the return that I would like to achieve by the end of the investment period? How willing am I to take risks? And how important is it to me to be able to access my invested money quickly in an emergency? Once you have set your individual investment goals and your risk profile, you can then decide on either strategic or tactical asset allocation.
What is the strategic asset allocation?
With the strategic asset allocation, investors commit to a certain asset mix and consistently maintain it over a long-term investment horizon. The aim of this method is an optimal balance between the assumed risk and the expected return. The strategic portfolio structuring is cyclical. This means that the weighting of the individual asset classes within the portfolio always remains the same – even if the economy and markets fluctuate. For this reason, the strategic asset allocation is also referred to as a “passive” form of portfolio structuring, because the portfolio is rarely reallocated.
What is the tactical allocation?
Tactical asset allocation known as more active form of portfolio management. The aim here is to temporarily weight certain asset classes more or less in order to benefit from current market developments in the short term. An example: during a bull marketOn the stock market, you temporarily add a higher proportion of stocks to your portfolio and return to your original portfolio structure when prices fall. In contrast to strategic asset allocation, investors shift their portfolios more often with tactical allocation. But even with the strategic asset allocation, you should occasionally check whether the weighting in your portfolio still corresponds to your original investment strategy – and if not, carry out what is known as rebalancing.
What does rebalancing mean?
Another important method that you should know about asset allocation is what is known as rebalancing . This term describes the reallocation of your asset classes to the original asset allocation. You should also know that the weighting of the individual asset classes can deviate significantly from your original portfolio structure over time, for example if the equity component increases or decreases significantly due to rising or falling prices. In concrete terms, rebalancing works by selling overweight shares or investing fresh money in underweight asset classes.
What are the advantages and disadvantages of asset allocation?
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Asset allocation offers the advantage that the capital can be distributed across different asset classes and the portfolio can be structured individually according to personal investment goals and risk tolerance. If investments are made in several asset classes with different risks and income opportunities at the same time, there is a greater chance that fluctuations can be more easily absorbed and possible losses can be offset by possible income in order to achieve the highest possible return overall. The asset allocation serves to diversify risk and is intended to prevent the overall risk from being on a single asset class. However, always be aware that even with a well thought-out asset allocation and even with an overweighting of supposedly less risky asset classes, you will always have to expect considerable fluctuations in the value of your portfolio and losses.