Asset Allocation

What is asset allocation? It is a strategy in allocating your available funds to different asset classes. These asset classes may include stocks, bonds, unit trust, cash etc. It is a MASTER PLAN of your INVESTMENT PORTFOLIO.

This is a very important exercise before any investment decision. Why is that so? Well, just imaging, if you have $1,000 on hand now, what will you do? OK, now, you might start to think on how to effectively use this $1,000. You might want to buy books and CDs you always dream of; you might want to go for a short trip; you might want to settle your personal loan. The list will go on. It is pretty normal for a person to have unlimited wants with limit funds. Therefore, you need to set the priority of these needs and wants and allocate your $1,000 accordingly. In this scenario, after some thought, you may set aside 10% or RM100 for savings as part of your emergency buffer. Next, you allocate 70% or $700 to offset your personal loan as this will save you interest. Finally, you might want to allocate the balance for books and CDs to feed you soul.

Get the picture?

For investment, we do the same thing. We have to decide how to allocate our funds based on our age, time horizon and risk tolerance level. For example, if you are a conservative investor, by allocating 70% of your investment fund in share will be far too risky for you and, therefore, you might want to reduce your exposure on share to less than 20%.

It is not advisable to overdependence on one asset class or two. The magic of diversification won’t work this way. We should first understand the nature of each asset class. Stocks investment will involve higher risk than bonds and so forth. To diversify the risk of investment, we should invest in different asset class with, if possible, negative correlation. For example, the chance of higher gold price is possible when stock market crash.

There is no right or wrong asset allocation. Each individual should have his/her own unique asset allocation structure. As I highlighted earlier, it has to be setup based on age, time horizon and risk tolerance level. As a general rule, assume our time horizon for investment for 5 years,

1. an aggressive investor should have higher exposure on stocks investment

2. a moderate investor should have the balance of stocks and bonds

3. a conservative investor should have more bonds

Happy investing.