Three Major Reasons of Asset Allocation

Saturday, February 12, 2011, 1:19 AM | Leave Comment

I have done a few posts on asset allocation. This is just an extension and a reminder for you – the investor – to review your asset allocation in the new year. It is advised by finance gurus to review it once every year if not more frequently.

Why is it the preferred way of investing? Well, there are so many benefits but three reasons stand out the most for an investor to allocate assets.

Three Major Reasons of Asset Allocation

  1. Reduce Risk through Diversification

    The old adage that an investor should not put all eggs in one basket has always held true. Diversification is the key to success in your investment strategy. Asset allocation involves not just buying several different stocks.

    But it also encompasses cash, bonds, inflation hedge assets, real estate, annuities and a whole bunch of other financial eggs.

    Selling one set of your assets and replacing them with others might be a good idea as long as you don’t sell (and buy) in your traditional panicky mode.

    More and more finance gurus agree and preach that one of the principal objectives of asset allocation is to increase the allocation of an asset class that has bottomed out and not when it is at the market top.

    It’s hard to recognize the top and bottom of the market. Otherwise, everyone would come out way ahead in their investments.

    All investments involve some kind of risk. Obviously, one of the main objectives in asset allocation is to minimize risks, thereby increasing rewards of investments.

  2. The Seasonal Attractiveness

    You need to understand two things to take advantage of the seasonal approach to asset allocation.

    Firstly, you need to get understanding of the characteristics of the various asset classes.

    Secondly, you need to identify the points in the business cycle when they traditionally do well.

    Following these two points, it is possible to attain superior returns relative to the risk undertaken.

  3. The Emotional Aspect

    When altering the composition of a portfolio, finance gurus advise that it should be done gradually and watch over it how best it performs over a certain period of time.

    Gradualism tends to take emotions out of the equation of any investment strategy.

    Gradualism in investment encompasses two aspects.

    Firstly, the odds of being right increases with more abundant evidence. Because the evidence whether you have done well or not usually emerges in a slow and somewhat frustrating manner, the allocation of asset should follow the same slow process.

    Secondly, the most important investment objective should be to maintain principal. In order to do that, you need a larger percentage of gain to overcome a loss.

In a Nutshell
Human psychology plays a big part in investing our hard-earned money. We are tempted to buy when the market is way up and sell when the market is down.

Following the three principal principles might give you a better chance of coming ahead in your investments.

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