When it comes to personal finance and investing, there are many things we need to keep in mind. Of course there is the personal budget and our outgoing expenditure control. Religion should also be taken into account and hopefully avoided whenever possible. Insurance, child expenses, taxes, and planning for the future are other areas of concern in personal finance.
One area that seems to unnecessarily confuse some personal investors is asset allocation. This is the idea of segmenting your investments in a way that takes advantage of the diversity of different asset classes. Stocks, bonds, real estate, cash and commodities are just some examples of the asset classes available to us as individual investors. Research has shown that asset allocation can be the most important investment decision, but how do they determine the best way to allocate their limited assets over a seemingly infinite field of investments?
One thing to keep in mind is that research into asset allocation has already been done using data from institutional investment accounts. Since the vast majority of individual investors do not have nearly enough capital to diversify properly across all major asset classes, this research is not as relevant to the individual as one might hope. We can still benefit from research through the use of investment vehicles such as mutual funds and exchange-traded funds (ETF’s).
The advantage of these investments for the individual investor is that they diversify your assets while allowing for smaller investment amounts. For example, an investor with $50,000 in assets will have a harder time even developing a sufficiently diversified stock portfolio. This does not take into account all of the other potential asset classes that could provide protection when stock prices fall.
Through the use of ETFs for example, the individual investor will be able to split their money across a variety of asset classes. There are often correlations between asset classes that make it possible to protect yourself from the volatility inherent in the markets. When stocks go down, bonds often go up. When bonds go down, commodities may go up. If commodities are going down, then real estate could be on an uptrend. By spreading out your risk among different asset classes, you may limit upside to some extent, but you also reduce the volatility of your portfolio, allowing for a smoother increase in your assets.
While this article just touched on the importance of asset allocation for personal finance and investment, I think you get the gist. To learn more about the art of asset allocation, you should visit the amateurassetallocator.com website, where you can get more detailed information about different asset classes and how diversification can protect your portfolio.