Portfolio allocation is the most important investment decision because you have to consider classes of assets before allocating specific proportion in the portfolio. It will help you to achieve your financial goals and decrease the chances of risk. Portfolio allocation covers different classes of assets and proportion of dollars investments are assigned to each asset class. Asset class is a broad category as it features equities, fixed income bonds, commodities, real estate and alternate investments. You can plan different types of investments from each asset class. For instance, equities cover individual stocks, stock options, stock-based mutual funds and exchange traded funds. The major concepts feature broad category of different types of assets.
Portfolio allocation requires determining the percentage of portfolio according to each asset class. It will help you to take the decision about the withdrawal of money and the size of portfolio according to your capacity.
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Asset Classes and Diversification
Assets are usually divided into different classes and each asset class has its own unique return. Equities are considered more aggressive types of assets because these can produce higher return but they have bigger fluctuations in value. Fixed income is considered as more conservative as the bonds can pay steady stream of income and fluctuate less in value and typically return the money at predetermined date. Commodities and real estate are different than stocks and bonds as they often produce returns.
Allocation strategy will help you to evaluate the characteristics of each asset class so that investor can get a portfolio with low tolerance for risk that can focus on preserving capital. You can allocate major portions of your portfolio to bonds and other fixed-income investments. On the other hand, if you want high risk tolerance then you can allocate equities to the major portion of your portfolio.
As a wise investor, you cannot allocate your portfolio to one single asset class because the investor should not put all of his/her eggs in one basket. Portfolio allocation in single category will not grow your income at sufficient rate. Do not allocate only equities as it can adversely affect by the market. This can put your investment at risk and as a result you will lose bigger part of your wealth.
You have to consider the diversification to reduce the risk by combining the various asset classes. Selection of right assets on right time is necessary for a successful portfolio.
Selection of Asset Classes
You have to know about the asset class to take the investment decision. Your selection should be based on your risk tolerance and financial goals. You can lower your risk tolerance via a general rule of thumb by allocating fixed income to the larger percentage of your portfolio. Investors with lower risk tolerances should allocate at least 50 percent of their portfolios to bonds and the remainder to stocks. Investors who want higher risk tolerance can allocate 70 percent of their portfolios to stocks and remainder to fixed income. Your financial plan may require a more conservative allocation or more aggressive allocation.
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