This leads to selling low and buying high, the exact opposite of prudent investing.īecause the three main asset classes - equities, fixed-income, and cash equivalents - have different levels of risk and return, each will behave differently over time. The goal is to select an asset allocation that lets you sleep at night, and avoid the destructive urge to sell out in a panic the next time the market plummets then having to agonize over when its a "good time' to get back in. The main asset classes are equities ( stock), fixed-income ( bonds) and cash. It may be changed due to life events, but it should not be changed due to market conditions. Strategic asset allocation is used by investors following the Bogleheads® investment philosophy. With a strategic asset allocation - as explained in this article - an investor selects a base target allocation to a selection of different asset classes for the long run. These balanced portfolios help reduce volatility and down-side risk, thus better enabling an investor to maintain a long term investment program (stay the course) without panic selling during bear markets. All four of these factors suggest more bonds as we age." Strategic asset allocationĪ key reason for devising an asset allocation strategy is to help an investor reduce the risk inherent in volatile equity asset classes that are expected to provide higher returns by combining these asset classes with more stable fixed-income assets. John Bogle advises that "as we age, we usually have (1) more wealth to protect, (2) less time to recoup severe losses, (3) greater need for income, and (4) perhaps an increased nervousness as markets jump around. So, higher stock allocations may be suitable since big drops in stock prices will not hurt as long as you do not flee the market. When you are young, your prime earning years lie ahead, and it will be decades before you need to access the money. The more risk you can handle, the less bonds you need. How much in bonds? How much in stocks? That's the basic question of asset allocation.
While this may sound like a daunting task, there are straightforward guidelines to help in selecting an appropriate asset allocation. These depend on the investment time horizon and on both the investor's financial capacity and emotional capacity to tolerate risk and to stay the course. The asset allocation that works best at any given stage in an investor's life will depend largely on the need, ability and willingness of the investor to take risk. This process of determining which mix of assets to hold in a portfolio is a personal one. Asset allocation is both the process of dividing an investment portfolio among different asset categories, and the resulting division over stocks, bonds, and cash.
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