Asset Allocation: Why Consider Asset Allocation & Fundamental Elements

Dec 11 2022 | 5 min

Knowledge Hub: Asset Allocation

Introduction

Asset allocation is the architectural blueprint for your investment portfolio. Rather than a chaotic collection of securities acquired over time, it is the result of a holistic, systematic process built around your preferences and needs.

Unlike ”stock picking,” which is about selecting individual securities, asset allocation examines how the various categories of securities—stocks, bonds, alternative investments, etc.—perform as a group.

The result of a well-conceived asset allocation is a portfolio that achieves the required return at the lowest risk.

Why consider asset allocation?

A common approach amongst investors is to build a portfolio of ”winners.” The most important question is ”What stocks will generate the highest returns?” Following this strategy, an investor attempts to pick the next Apple or Tesla.

Besides being very difficult (even for experts), attempting to pick winners is not a prudent approach to investment. Asset allocation attempts to answer the question, “What combination of assets will help me achieve my objectives?” It requires consideration of three factors, specific to the investor:

Goals: These are a combination of short-term and long-term goals. These may include the provision of ongoing income after retirement, support for family members, and charitable causes. These goals translate into a required rate of return that the portfolio must deliver.
  • Risk tolerance: Investments carry different levels of risk. Investors also differ in their ability to endure declines in the value of their investment portfolio. An investor with a low tolerance for risk may be prone to make unwise decisions (such as selling at the bottom of a crash). Investors should remain with their risk tolerance.
  • Investment horizon: Investors may be well advised to accept greater risk when there is time for a portfolio to recover and there is no pressing need to make withdrawals. The investment horizon is often reflected in asset allocation. The shorter the horizon, in general, the less risky the portfolio.
  • Based on the above factors, we can proceed to develop a portfolio that meets the risk-and-return profile of the investors. Below are the principle tools of asset allocation.

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    Fundamental elements of asset allocation

  • Diversification

  • By building a portfolio of uncorrelated investments (i.e. investments that do not behave similarly), the gains in some investments in the portfolio tend to offset losses in others. This reduces the risk of the portfolio while preserving the return.

  • Risk management

    Managing the risk of a portfolio is key to ensuring the sustainability of returns. We do this by identifying, measuring, monitoring, and hedging against the various forms of risk to which investments are exposed.

  • Rebalancing

  • Not all parts of a portfolio achieve their expected growth. Hence, an asset allocation may deviate from the original blueprint over time. Rebalancing corrects this natural drift and uses gains in well-performing assets to invest in attractively-priced opportunities.

  • Reinvestment

  • The power of compounding depends on the growth of the portfolio and the passage of time. Reinvesting income, such as dividends, is a straightforward, powerful way to increase growth and enhance the final value of a portfolio.

  • Asset protection

    It is not possible to eradicate fraud or incompetence, but vigilance goes a long way to ensuring that your assets remain secure and available when you need them. Understanding issues such as custody, identity security, and who is charging you for what can prevent you beyond from many kinds of harm.

  • We’ll explore all of these five areas in more detail in separate articles in this section. Meanwhile, please consult your advisor or contact The Family Office for any questions or assistance.

Disclaimer

This presentation is provided to you by The Family Office Co. BSC(c) (“The Family Office”) for informational purposes only, and contains proprietary information that may not be reproduced, distributed to, or used by, any third parties without The Family Office’s prior written consent.

All information, figures, calculations, graphs and other numerical representations appearing in this presentation have not been audited and may be subject to change over time. Furthermore, certain valuations (including valuations of investments) appearing in this presentation are subject to change as they may be based on either estimates or historical figures that do not reflect the latest valuation. Although all information and opinions expressed in this presentation were obtained from sources believed to be reliable and in good faith, no representation or warranty, express or implied, is made as to their accuracy or completeness. The information contained herein is not a substitute for a thorough due diligence investigation. Past performance is not indicative of and does not guarantee future performance. Exit timelines, prices and related projections are estimates only, and exits could happen sooner or later than expected, or at a higher or lower valuation than expected, and are conditional, among other things, on certain assumptions and future performance relating to the financial and operational health of each business and macroeconomic conditions.

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The Family Office is a Category 1 Investment Firm regulated by the Central Bank of Bahrain C.R.No.53871 dated 21/6/2004. Paid Up Capital: US$ 10,000,000. The Family Office only offers products and services to ‘accredited investors’ as defined by the Central Bank of Bahrain.

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