The Importance of Asset Allocation
In the world of investing, people often want to know what the best investment is for them. The answer is not only what to invest in, but more importantly how to invest. There are many ways to invest money, but ultimately most investments in the financial world come down to stocks and bonds. People who own mutual funds or annuities may not realize it, but all they really own is a stock, a bond, or both with several intermediaries in between. The simplest and purest way to invest will always be to own individual stocks and bonds outright. Now, which should you own?
The answer in most cases is both, but to what degree? The younger person should own more stocks which carry more risk, better defined as volatility, with more opportunity for return. The older person should own more bonds which carry less risk with less opportunity for return. That being said, how a person feels about the volatility they are exposed to should carry much more weight than their stated age says they should expose themselves to.
Why so much emphasis on asset allocation?
During stock market corrections, fear is high and no one feels that stocks are the place money should be; however, a proper adherence to asset allocation tells us differently. When markets hit all-time highs, people are euphoric and feel the good times are just getting going for moving money into stocks, but utilizing a disciplined approach through asset allocation tells us differently.
Over long periods of time adhering to an asset allocation will force an investor to reduce exposure to stocks as markets rise and move those funds into bonds. When markets fall, the asset allocation will force the investor to move more money into stocks. This is the basis of the model we created at B&C Financial. By following this simple discipline someone will buy low and sell high, which is Investing 101. This goal will be accomplished without trying to time market movements which many claims to prophesize, but few often do. While sounding simple, the actual process takes years to produce efficacy. Additionally, emotion must be removed from the decision making process. We are human after all and must avoid allowing emotions to interfere with the investment process.
It is for these reasons a proper asset allocation will always see the investor through when they are properly diversified. In the future, we will cover how proper diversification is achieved.