Each of us is constantly allocating personal resources. We have an umbrella for rainy days and sunglasses for sunny days. We fill our bathroom cabinet with cold and cough medicine for those days we can’t get out of bed and headache medicine for those days we can’t stand to watch the stock market.
This allocation is constantly shifting, based on what we have and what we anticipate needing to use. But our primary goal stays constant: to reduce our risk of not being prepared on any given day.
The approach we take with investing should mimic the habits we maintain in our personal lives. The means by which this is accomplished is “asset allocation.”
Asset allocation is an investment strategy that involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. At BWFA, our first priority is to tailor the asset allocation of investment portfolios to each client’s individual circumstances. Two of the primary determinants of an appropriate asset allocation are a client’s time horizon and ability to tolerate risk. Using these attributes as a guide, we create portfolios that we believe will provide the greatest possible return given the client’s risk tolerance, financial goals, and circumstances.
Asset allocation does not prevent portfolio losses, but it can help to minimize losses and reduce the volatility of returns over the long term. The consequences of volatility, as measured by standard deviation, become more apparent over time. For example, a portfolio that is down 50 percent requires a 100-percent increase just to get back to the original value, but a portfolio that is down 9 percent requires only a 9.9-percent increase to get back to the original value. The more frequently a portfolio experiences severe losses due to volatility, the less advantageous will be the compounding effects of positive returns.
A properly allocated portfolio is one of the most important factors affecting the long-term performance and overall risk of your investments. Appropriately implemented, asset allocation acts as an effective defense against market volatility, inflation, and global economic turmoil. Please contact a BWFA professional or stop by our offices if you’d like to discuss your specific asset allocation strategy.
| Asset Allocation, Balanced Portfolios and the S&P 500 Index |
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| Balanced portfolios like those managed at BWFA include multiple asset classes, each having a unique set of risk and return characteristics. One challenge is to determine what is an appropriate index against which to compare the performance of a portfolio.
Many investors look at the S&P 500 as the best index. In fact, the S&P 500 is commonly referred to as the “market.” But equating the S&P 500 with the entire stock market is misleading. The S&P index is made up of only a single asset class: U.S. large-capitalization stocks. Since risk and return are related, it can be surmised that over the long term a balanced portfolio would be expected to produce a different return from the S&P 500 index. The S&P 500 index would not be a suitable benchmark for comparison to a balanced portfolio, unless the portfolio has a 100-percent allocation to U.S. large-cap stocks. |