Balancing Asset Allocation: Mitigating Investment Risk in a Changing Market

Asset allocation determines how money in a financial portfolio is invested. Balancing your asset allocation can help limit your financial risks while maximizing profits.

What Is Asset Allocation?

Asset allocation refers to how you choose to allocate your financial assets. More specifically, asset allocation describes which financial assets you select and how much money you invest in each of them.

Understanding your asset allocation is important because it helps mitigate the risk of financial losses. Some assets, like stocks, could potentially be worth a lot more in the future but can fluctuate in value over time, which means you could potentially lose some (or all) of your investment. This risk is why most financial experts recommend investing in mutual funds over picking individual stocks.

Other assets, like bonds, will appreciate or depreciate much more slowly. While you might earn a lot less with bonds compared to stocks, you aren’t likely to lose as much money, either. Investing in bonds is generally a lot safer than investing in the stock market, though your returns won’t likely be as high. Because of these differences, most people choose a combination of stocks, bonds and other assets when building their investment portfolio to maximize growth and limit their losses.

Balancing Risk and Return

A balanced portfolio spreads your money across multiple investments so that you can withstand fluctuations in the market, but there are times when having an unbalanced portfolio might be in your best interest. For example, if you’re nearing retirement age, you’ll likely want to avoid large fluctuations in the value of your investment portfolio. As a result, you might choose to put the bulk of your money into the least volatile types of investments, like cash, savings accounts, or certificates of deposit (CDs). But if you still have a long time to invest, you’ll likely see larger growth over time by choosing stocks and other investments that come with a higher level of risk and higher potential returns.

That said, a more evenly balanced portfolio tends to have better results, as long as you’re comfortable with short-term price fluctuations across a medium-to-long period of time. Choosing to invest in both stocks and bonds, in addition to other types of investments, is an excellent way to maintain your financial health while still getting a decent return on your investment.

Keep in mind that a set of investments that works well for one person won’t necessarily work for another person. Asset allocation is a very personal choice, as the U.S. Securities and Exchange Commission points out. There is no perfect investment, which means you need to consider personal factors like your age, current financial situation and how much risk you’re comfortable with before choosing assets for your financial portfolio.

Asset Allocation and Diversification

Common types of assets include stocks, bonds and cash, but there are also less common assets like real estate, private equity and precious metals you can add to your investment portfolio. Each asset type offers a unique value, which means you are the only one who can decide which assets belong in your investment portfolio and how to diversify those assets. 

Generally, people who still have many years for their investments to grow should invest more money in stocks, while people who are closer to retirement age should invest more funds in bonds. If you subtract your age from 100, that will give you an idea of the percentage of your portfolio that should be allocated to stocks versus bonds. Based on this formula, a 40-year-old should have about 60% of their portfolio invested in stocks, while the rest is made up of less volatile assets like bonds and cash.

But it’s important to remember that not every rule applies to everyone or every situation, so working with a financial advisor is the best way to balance your asset allocation in a way that makes sense for you.

Intentional Asset Allocation

Because your finances are limited, investments require intentional planning on your part. You need a strategy to determine what you should (and shouldn’t) include in your investment portfolio so that you can reach your retirement goals. There are several factors to consider when allocating assets, including how long you have for your investments to grow, your overall financial goals and your level of risk tolerance.

Working with a Professional

The best way to determine which asset allocation strategy is right for you is to work with a financial professional who can help you with the following tasks:

• Identify financial goals: What are your financial goals? Would you be happy to spend your retirement having potluck dinners with friends, or do you want to spend most of your retired years traveling internationally? A professional financial advisor can help you balance your asset allocation so you can afford to retire in a way that feels right for you.
• Determine your risk tolerance: Does the thought of your portfolio going up and down over time make you nervous, or are you comfortable with a little market volatility? A financial advisor can help mitigate investment risks in a way that works for your comfort level.
• Figure out your timeline: Are you retiring in two years? 10 years? 25 years? A financial advisor can help you balance your portfolio so your money is ready whenever you decide to retire.
• Choose your assets and investments: After you’ve decided how to allocate your assets, you’ll need to determine exactly which investments you want to include in your portfolio. There are many different types of investments, so working with a financial advisor is a good way to choose investments that meet your financial goals, risk tolerance and personal preferences.
• Review your portfolio annually: Once everything is in place, you’ll need to review your portfolio each year to make sure it still meets your needs.

Editor Norah Layne contributed to this article.