A common piece of advice you’ve probably heard before is to “save and invest.” Saving is easy to understand but what does it mean to invest? Investments come in a variety of forms, but all follow a similar principle: allocating assets toward projects or activities that are expected to generate a positive financial return over time. When you do invest, however, it is even more important that you are investing an appropriate amount into specific financial vehicles to meet your investment goals.
Asset Allocation
Deciding how much to invest in each investment type is one of the most important considerations for an investor. That balance between potential growth, income and stability is called your asset allocation. It doesn’t guarantee a profit or insure against a loss, but it does help you manage the levels and types of risk you face.
When many people discuss asset allocation it tends to be a reference to the financial markets involving stocks, bonds and cash or cash alternatives. Other investment classes can include real estate, hedge funds, private equity, metals or collectibles. These additional asset types can be used to complement an investor's portfolio once the basics are covered. Asset allocation can go even deeper and be used within each asset class. For example, your investments in equities (stocks) could be in large-cap funds (big companies), small-cap funds (small companies) and international investments, etc. Every investment has potential risks and rewards that can be used to tailor your portfolio. Understanding what you need as an investor is a good place to start.
Risk & Reward
Your investment goals, time horizon and risk tolerance should drive your asset allocation decisions. In investing, more risk comes with more return potential although nothing is ever guaranteed. You should strive for a combination of investments that can help you achieve the growth you need while also balancing the risks you as an investor are willing to take on. A young investor with a longer timer horizon until they need those assets may be able to take on more risk, stomach the volatility day to day, and potentially receive a greater return in the long run. An older investor who is reliant on their invested assets for their retirement income may have a much shorter time horizon, causing them to take less principal risk and choose an allocation set towards preserving their assets over growing them.
Riskier investments tend to have a higher potential return to make up for the fact that it is riskier. Investments that aren’t as risky may have lower potential returns because people are willing to accept smaller return potential for less risk. Different investment sectors have performed differently over time, giving investors an understanding of the potential risks and returns associated with them. As the world changes around us, so do investments.
Diversification
Diversification is another key topic to consider in your asset allocation. This relates to the adage “Don’t put all your eggs in one basket.” If all your money is in one investment (or investment type) and that investment does poorly, you could lose everything. Diversification is a proven way to decrease the risk in an investor's portfolio by spreading investments across a multitude of sectors to limit exposure to any one type of asset. This can help reduce the volatility of your portfolio over time. The key to doing this is to mitigate risk and increase the potential for returns.
For example, the equities (stocks) in an investor portfolio could be diversified with large-cap, small-cap, international, emerging markets and so on. These could go even more specific between sectors that include technology, health care, energy, utilities, etc. The choice of deciding which of these investments make up your portfolio goes back to understanding your time horizon, risk tolerance and personal situation. There is no “right” answer when it comes to asset allocation. It is more important that your investing strategy is aligned with your financial goals.
Two of the easiest ways to diversify your portfolio without needing to buy individual stocks and bonds is through mutual funds and exchange-traded funds (ETFs), which typically offer exposure to a wide variety of asset classes and niche markets. These fund types allow for more diversification than a single stock or bond while also trading in the market similarly to normal securities.
Monitoring and Adjusting Over Time
As time goes on and your life changes, so will your goals. This is why monitoring and adjusting your investments is crucial. It's important to align your investments with your evolving goals to avoid concentrated positions and to ensure you are taking an appropriate level of risk. Different assets will experience varying levels of gains and losses, which can shift your portfolio out of its intended allocation. When this happens, rebalancing is necessary. It's essential to understand what you are buying and selling, as well as the tax consequences associated with these transactions before making them.
Review your strategy and allocation at least once a year, maybe more depending on your circumstances. The experienced team with Busey Wealth Management is here to help you on your financial journey. To learn more about our services or find an advisor near you, please 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.
