A chocolate cake. Pasta. A pancake. These items are very different, but they generally involve the same ingredients—flour, eggs and perhaps a liquid. Depending on how much of each ingredient you use, you will encounter very different outcomes.
The same is true for your investments—depending on what asset classes comprise your portfolio and how much of each class you hold, your results will be very different. Balancing a portfolio means combining various types of investments using a recipe that's appropriate for you.
Finding an appropriate mix
The combination of investments you choose can be as important as the specific investments themselves. The mix of various asset classes—such as stocks, bonds and cash alternatives—account for most of the ups and downs of a portfolio's returns.
Each type of investment has strengths and weaknesses that enable it to play a specific role in your overall investing strategy. Some investments may be chosen for their growth potential, others may provide steady income, some may offer safety and some investments try to fill more than one of these roles. You will need some combination of investment types to maximize the potential of meeting your investment goals.
Balancing risk and return
Ideally, you should strive for an overall combination of investments that minimizes the risk you take in trying to achieve a targeted rate of return. This often means balancing more conservative investments against others that are designed to provide a higher return yet may involve some additional risk.
Your mixture of investments should also align with your unique goals. For example, someone living on a fixed income whose priority is having access to a consistent and reliable stream of funds will likely need a different asset allocation than a young, working professional whose priority is saving for a retirement that's 30 years away.
To help jump-start your thinking about how to divide up your investments, there are model investment portfolios that recommend generic asset allocations based on an investor's age. These models are a great place to start, but they shouldn't be seen as definitive. Your asset allocation is—or should be—as unique as you are. Even if two people are the same age and have similar incomes, they may have very different needs and goals. Make sure your asset allocation is tailored to your individual circumstances.
Many ways to diversify
When financial professionals refer to asset allocation, they're usually talking about overall classes—stocks, bonds and cash or cash alternatives. However, there are others that can be used to complement the major asset classes such as real estate, hedge funds, private equity, metals or collectibles.
Even within an asset class, consider how your assets are allocated. For example, if you're investing in stocks, you could allocate a certain amount to large-cap stocks and a different percentage to stocks of smaller companies. Bond investments might be allocated by various maturities, with some money in bonds that mature quickly and some in longer-term bonds.
Asset allocation strategies
There are various approaches to calculating an asset allocation that makes sense for you. The most popular approach is to look at what you're investing for and how long you have to reach that goal. Those goals should be balanced against your more immediate needs, such as money for living expenses.
Many investors try to match market returns with an overall "core" strategy for most of their portfolio. They then put a smaller portion in very targeted investments that may behave differently from those in the core and provide greater overall diversification. Often, these are asset classes that could benefit from more active management. Additionally, just as you allocate your assets in an overall portfolio, you can allocate certain assets for a specific goal. For example, you might have one asset allocation for retirement savings and another for college tuition.
Things to consider
- Don't forget about the impact of inflation on your savings. As time goes by, your money will buy less and less unless your portfolio at least keeps pace with the inflation rate. Even if you think of yourself as a conservative investor, your asset allocation should take long-term inflation into account.
- Your asset allocation should balance your financial goals with your emotional needs. If the way your money is invested keeps you awake at night, you may need to rethink your investing goals and consider whether the strategy you're pursuing is worth abandoning your peace of mind.
- Your tax status might affect your asset allocation, but your decisions shouldn't be based solely on tax concerns. Even if your asset allocation was right for you when you initially chose it, it may not be appropriate for you now—it should adapt as your circumstances change.
Building an investment portfolio that is uniquely tailored to your goals can be challenging, which is why Busey offers individualized wealth management services to our customers. To learn more about the comprehensive services offered by Busey Wealth Management, visit busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.
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