Balancing Your Investment Choices with Asset Allocation

Miles B. Kessler, CFP®Investment Representative

870 Kipling StreetSuite A

Lakewood, CO 80215-5826Direct: 303-290-8942

Branch: 303-238-5123mileskessler@royalaa.com

January 28, 2016

A chocolate cake. Pasta. A pancake. They're all verydifferent, but they generally involve flour, eggs, andperhaps a liquid. Depending on how much of eachingredient you use, you can get very differentoutcomes. The same is true of your investments.Balancing a portfolio means combining various typesof investments using a recipe that's appropriate foryou.

Getting an appropriate mixThe combination of investments you choose can beas important as your specific investments. The mix ofvarious asset classes, such as stocks, bonds, andcash alternatives, accounts for most of the ups anddowns of a portfolio's returns.

There's another reason to think about the mix ofinvestments in your portfolio. Each type of investmenthas specific strengths and weaknesses that enable itto play a specific role in your overall investingstrategy. Some investments may be chosen for theirgrowth potential. Others may provide regular income.Still others may offer safety or simply serve as atemporary place to park your money. And someinvestments even try to fill more than one role.Because you probably have multiple needs anddesires, you need some combination of investmenttypes.

Balancing how much of each you should include isone of your most important tasks as an investor. Thatbalance between growth, income, and safety is calledyour asset allocation, and it can help you manage thelevel and type of risks you face.

Balancing risk and returnIdeally, you should strive for an overall combination ofinvestments that minimizes the risk you take in tryingto achieve a targeted rate of return. This often meansbalancing more conservative investments againstothers that are designed to provide a higher return butthat also involve more risk. For example, let's say youwant to get a 7.5% return on your money. Yourfinancial professional tells you that in the past, stock

market returns have averaged about 10% annually,and bonds roughly 5%. One way to try to achieveyour 7.5% return would be by choosing a 50-50 mix ofstocks and bonds. It might not work out that way, ofcourse. This is only a hypothetical illustration, not areal portfolio, and there's no guarantee that eitherstocks or bonds will perform as they have in the past.But asset allocation gives you a place to start.

Someone living on a fixed income, whose priority ishaving a regular stream of money coming in, willprobably need a very different asset allocation than ayoung, well-to-do working professional whose priorityis saving for a retirement that's 30 years away. Manypublications feature model investment portfolios thatrecommend generic asset allocations based on aninvestor's age. These can help jump-start yourthinking about how to divide up your investments.However, because they're based on averages andhypothetical situations, they shouldn't be seen asdefinitive. Your asset allocation is--or should be--asunique as you are. Even if two people are the sameage and have similar incomes, they may have verydifferent needs and goals. You should make sureyour asset allocation is tailored to your individualcircumstances.

Many ways to diversifyWhen financial professionals refer to asset allocation,they're usually talking about overall classes: stocks,bonds, and cash or cash alternatives. However, thereare others that also can be used to complement themajor asset classes once you've got those basicscovered. They include real estate and alternativeinvestments such as hedge funds, private equity,metals, or collectibles. Because their returns don'tnecessarily correlate closely with returns from majorasset classes, they can provide additionaldiversification and balance in a portfolio.

Even within an asset class, consider how your assetsare allocated. For example, if you're investing instocks, you could allocate a certain amount tolarge-cap stocks and a different percentage to stocks

Even if your assetallocation was right foryou when you chose it, itmay not be appropriatefor you now. It needs tochange as yourcircumstances andpriorities change.

Asset allocation anddiversification cannotguarantee a profit orinsure against a loss.There is no guaranteethat any investmentstrategy will besuccessful; all investinginvolves risk, includingthe possible loss ofprincipal. There is noassurance that workingwith a financialprofessional will improveinvestment results.

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of smaller companies. Or you might allocate based ongeography, putting some money in U.S. stocks andsome in foreign companies. Bond investments mightbe allocated by various maturities, with some moneyin bonds that mature quickly and some in longer-termbonds. Or you might favor tax-free bonds over taxableones, depending on your tax status and the type ofaccount in which the bonds are held.

Asset allocation strategiesThere are various approaches to calculating an assetallocation that makes sense for you.

The most popular approach is to look at what you'reinvesting for and how long you have to reach eachgoal. Those goals get balanced against your need formoney to live on. The more secure your immediateincome and the longer you have to pursue yourinvesting goals, the more aggressively you might beable to invest for them. Your asset allocation mighthave a greater percentage of stocks than eitherbonds or cash, for example. Or you might be in theopposite situation. If you're stretched financially andwould have to tap your investments in an emergency,you'll need to balance that fact against yourlonger-term goals. In addition to establishing anemergency fund, you may need to invest moreconservatively than you might otherwise want to.

Some investors believe in shifting their assets amongasset classes based on which types of investmentsthey expect will do well or poorly in the near term.However, this approach, called "market timing," isextremely difficult even for experienced investors. Ifyou're determined to try this, you should probably getsome expert advice--and recognize that no one reallyknows where markets are headed.

Some people try to match market returns with anoverall "core" strategy for most of their portfolio. Theythen put a smaller portion in very targetedinvestments that may behave very differently fromthose in the core and provide greater overall

diversification. These often are asset classes that aninvestor thinks could benefit from more activemanagement.

Just as you allocate your assets in an overallportfolio, you can also allocate assets for a specificgoal. For example, you might have one assetallocation for retirement savings and another forcollege tuition bills. A retired professional with aconservative overall portfolio might still becomfortable investing more aggressively with moneyintended to be a grandchild's inheritance. Someonewho has taken the risk of starting a business mightdecide to be more conservative with his or herpersonal portfolio.

Things to think about• Don't forget about the impact of inflation on your

savings. As time goes by, your money willprobably buy less and less unless your portfolio atleast keeps pace with the inflation rate. Even if youthink of yourself as a conservative investor, yourasset allocation should take long-term inflation intoaccount.

• Your asset allocation should balance your financialgoals with your emotional needs. If the way yourmoney is invested keeps you awake worrying atnight, you may need to rethink your investing goalsand whether the strategy you're pursuing is worththe lost sleep.

• Your tax status might affect your asset allocation,though your decisions shouldn't be based solely ontax concerns.

Even if your asset allocation was right for you whenyou chose it, it may not be appropriate for you now. Itshould change as your circumstances do and as newways to invest are introduced. A piece of clothing youwore 10 years ago may not fit now; you just mightneed to update your asset allocation, too.

No simple answers

You may have heard thiswidely known rule of thumb:To figure out thepercentage of yourinvestments that should bein stocks, subtract your agefrom 100. However, this ishardly a comprehensivestrategy. Deciding on anappropriate asset allocationinvolves more than simplylooking at your age. Yourfinancial professional canhelp you choose acombination that takes intoaccount your goals, risktolerance, and overallfinancial situation.

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