Asset allocation refers to placing your investments into different classes - stocks, bonds or cash – and is an absolutely critical part of investing. Investment classes include the various types listed below:
There are two distinct strategies concerning asset allocation; passive asset allocation and active asset allocation.
Passive asset allocation begins by an investor setting specific percentages for each asset class. Once the investor has determined their optical allocation they purchase securities in each of their asset classes. These percentages should be maintained over time. These ratios will change as the value of each asset class change. As the value of each asset class changes the investor should rebalance their portfolio yearly to maintain their specific percentages.
Active asset allocation refers to changing the composition of investment classes based on market conditions. This strategy is called market timing.
Research has shown that approximately 90% of an investment performance is determined by the asset allocation of the portfolio. In other words, buying a wide range of stocks and bonds as a long term investment is more important than trying to time the market. Market events make great news but don’t have much impact over the long term.
For this reason, Waverley Research believes that a passive allocation strategy is best suited for the average investor.