Asset allocation is a method of portfolio construction that encourages the spreading of assets across several macro-categories such as cash, stocks, bonds, and alternatives. Each of these macro-categories also have sub-categories within them that should be considered in an overall asset allocation. For example, stocks would include the sub-categories of large-cap growth, small-cap value, developed markets, emerging markets, micro-cap, etc. Which asset allocation is best for you is determined by several factors such as your age, your tolerance for risk and the time horizon for the goal that you are saving for. Asset allocation allows us to thoughtfully think about positioning the risk profile of our portfolio suitable to the client’s goals and objectives. Asset allocations with large upside potential also carry a larger downside potential and may require a longer time horizon. Asset allocations which exclude stocks and are heavily-weighted in cash and short-duration bonds may be better suited for shorter-term investments.
Asset-allocation in combination with diversification are some of the primary ways that we look to mitigate and manage risk in an overall portfolio construction. While diversification is designed to mitigate the market risk of a particular security, asset allocation adds to the mitigation by not just looking at the mix of securities but the consistencies among them and looking for non-correlating sub-categories. Asset allocation strategies are designed in an effort to optimize risk and reward, but cannot guarantee a profit or protect against a loss.