Asset Allocation for Individuals

Asset allocation for individuals. What is the best possible asset allocation for your needs?

Importance of Asset Allocation

Asset allocation is a conservative strategy that will not generate extremely high or extremely low returns. However, it is a low-risk approach that is very attractive, especially if you do not merely seek to be on the headlines. If your investment objective is to accumulate wealth, asset allocation is an excellent strategy to follow.

Finding the Right Asset Allocation

As Richard Ferri notes, there are three basic steps to asset allocation.

First, determine the portfolio’s overall equity and fixed-income mix based on an investor’s needs and tolerance for financial risk.

The equity and fixed income mix affects the portfolio’s risk and returns most significantly. Asset allocation portfolios are thus usually built from a basic mix of US stocks and bonds. Investors then try to locate asset classes that are negatively correlated to these basic US stocks and bonds, in order to build the rest of the portfolio

Second, develop a portfolio of fundamentally different investments that are expected to have a low correlation with one another and are expected to deliver a fair rate of return given each investment’s inherent risk.

Unfortunately, given the high unpredictability of world events, correlations among investment and asset classes can change suddenly and without notice. It is thus impossible to truly design a portfolio with investments that are entirely negatively correlated.

Third, rebalance the investments annually to control overall portfolio risk and increase long-term return.

Types of Asset Classes

US Equities (Historically high return, high correlation with REITs)

International Equities (Historically high return, high correlation with REITs)

Fixed Income Investments – the US and the international bond markets (Historically moderate return, moderate risk)

Real Estate Investments (Historically high return, high correlation with equities)

Commodities (Historically low return, low correlation with other asset classes)

Collectibles (Illiquid, high volatility)

Asset Allocation for Individuals

For specific asset allocation advice for different investor types: Recommended Asset Allocation.

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