The Importance of Asset Allocation

Asset allocation is one of the most important decisions you will make when it comes to investing, in addition to the decision to just get started. Still, many investors don’t do asset allocation correctly, meaning their portfolio doesn’t perform in a way that will support their goals.
Why Is Asset Allocation So Important?
Asset allocation is the decision surrounding what percentage of your investments should be in which asset classes—usually the choice is between equities, fixed income and cash. This has everything to do with your specific investing goals, even if you have many at once. If you don’t get your asset allocation right—let’s say your portfolio should’ve been 80% equities but it’s really 40% equities—it’s not going to matter how great your underlying investments are if you’re missing out on market performance. The flip side is also true. If your goals and time horizon indicate you should be invested 80% in equities and you are, it may not matter as much if that 80% sits in a mediocre mutual fund, as even a mediocre mutual fund is likely to perform well if its asset class is doing well.
A Common Asset Allocation Mistake
Asset allocation entails investing certain percentages of your portfolio in different types of securities. So why do so many investors inadvertently fill their portfolios with investments that are similar?
It’s easy to make this mistake because of the human tendency to look for investments with the best performance. When the market is doing well, the high tide lifts most, if not all, boats. So in a good market, if you’re assessing a number of different mutual funds and trying to decide where to put your money, many of the funds may appear similar when it comes to performance. Of course, the problem occurs when markets no longer perform well. If you’ve inadvertently chosen a selection of funds that are too similar to each other, they may all go down at same time, eliminating the benefit of diversification.
Seek Different Solutions When Building a Portfolio
Instead of searching for the best-performing funds, it’s crucial to search for investments that represent different sectors of the economy. In a diverse portfolio, some investments will perform better while others may even lose money. The whole point is that each plays a different role. If you concentrate your investments in just a couple areas or styles, you might open yourself up to increased risk if that one area declines.
Broadly speaking, make sure your investments expose you not only to broad asset classes but also to other types of diversification. So, within the broad class of “equities,” you can opt for a mix of large-cap growth, large-cap value, mid-cap, small-cap, domestic, international and so on. Within the bucket of “fixed income,” there are government bonds, corporate bonds, mortgage-backed securities and more.
At the end of the day, it’s important to make sure you have the right exposure to the areas that make sense for your goals and time horizon. A Financial Advisor familiar with your individual circumstances and broader financial goals can help you allocate your assets and build your portfolio as part of a comprehensive wealth management plan.
Article by Morgan Stanley and provided courtesy of Morgan Stanley Financial Advisor.
Brian Jacobs is a Executive Director in Valencia, CA at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). He can be reached by email at brian.jacobs@morganstanley.com or by telephone at (661) 290-2022.