Asset allocation is one of the most basic, but essential, aspects of sound investing. Empirical studies have shown that perhaps more than 90% of a portfolio’s variability of returns can be explained by strategic asset allocation.
The volatility that we have seen over the first four months of 2020 has made choosing an appropriate asset allocation even more significant.
Whether you feel you are taking on too much risk or want to gain more exposure to equities slowly, AAII and A+ Investor have resources to help you adjust your current portfolio to a more appropriate allocation.
AAII offers members three Asset Allocation Models for three investor “personas” that are based on investment time horizon and risk aversion: aggressive, moderate and conservative.
The asset allocation area can be found by clicking on the Investing menu from the navigation bar. Here you will find the traits generally exhibited by investors in these three categories:
Generally speaking, the younger the investor, and the longer their investing time horizon, the greater their willingness to accept risk and portfolio volatility.
Further down the page are suggested allocation breakdowns based on three different investor profiles—aggressive, moderate and conservative:
The broad asset allocation scenarios offer a clearer picture of each investor profile, showing the stock/bond allocation, risk and growth characteristics, time horizon and suggested transition allocations. You will find information such as the typical returns you can expect to generate and how much you can expect to lose in a very bad year as an aggressive, moderate or conservative investor.
The suggested allocations are meant to serve only as a guideline. Aggressive investors are generally thought of as being younger and conservative investors are usually older, although specific situations can call for diversions from this general rule. For instance, tenured professors with a steady income and virtually no risk of losing their jobs might be more aggressive with their portfolios than a young entrepreneur selling high-end jewelry.
The first steps in establishing an asset allocation strategy is knowing what kind of an investor you are and establishing a target asset allocation. The next steps are to execute that strategy and then perform periodic portfolio analyses and, if needed, make portfolio adjustments to maintain your desired asset allocation.
For A+ Investors, the Diversification Analyzer in My Portfolio gives a breakdown of how your portfolio is allocated based on the number of shares you’ve entered for each stock, mutual fund and exchange-traded fund (ETF) plus any dollar amounts you’ve entered for cash and/or bond holdings. This information is used to tell you if you are being too aggressive or not aggressive enough given your chosen investing profile.
The first time you click on the Diversification Analyzer tab, you are asked to define what type of investor you are:
For this example, the investor identifies as being moderate. The Asset Allocation Analyzer then presents an analysis of the selected portfolio compared to the selected asset allocation model. For mutual funds and ETFs, the analysis looks at the underlying portfolio, looking at cash and bond holdings as well as allocation between U.S. (domestic) and foreign (non-U.S.) stocks.
As the Asset Allocation Analyzer shows above, the actual portfolio’s allocation may be too aggressive, based on AAII’s asset allocation model.
Based on the moderate allocation model, this user’s portfolio is overweighted in equities as a group. However, at a more granular level, the portfolio is overweighted in domestic stocks (80.3% versus 50%) but is underweighted in foreign stocks (8.8% versus 20%).
Furthermore, the portfolio is underweight in bonds (10.2% versus 30%).
If this investor truly views themselves as someone who wishes to strike a balance between growing their portfolio yet not being overly aggressive and having some downside protection, they could use information as a sign to consider reducing their exposure to stocks and increasing their allocation in bonds. On the other hand, if the investor is comfortable with their current allocation, the diversification analyzer is showing that they are not as conservative of an investor as they may have previously thought.
The diversification analyzer is not intended to offer portfolio suggestions but is a means of helping investors identify whether they are as aggressive or conservative in their asset allocation as they think they are.
