This article was written in collaboration with Fundsupermart. All views expressed in the article are the independent opinions of DollarsAndSense.sg
Whenever new investors think about investing, their attention is mainly focused on what they should be investing in, how much returns they can potentially generate and the risk they will be facing.
While appreciating the risk/return tradeoff isn’t a bad way to start your investing journey, it is not the only important concept you need to understand.
Asset allocation is an equally important subject that many investors often tend to neglect, at their own peril. But what is asset allocation and why is it so important?
What Is Asset Allocation?
Asset allocation is an investment strategy that aims to balance between risk and reward by assigning a weightage to individual categories of assets in an investment portfolio. This is usually done with considerations to the investor’s risk tolerance, investment goals and investment time horizon.
For example, a conservative investor may allocate a greater proportion of his portfolio to government bonds and other high quality corporate bonds. At the other end of the spectrum, an aggressive investor, more willing to take on higher risk to achieve higher returns, could see majority of his portfolio invested in equities.
Here are two simple reasons why asset allocation is important.
#1 Optimise Your Risk/Return Tradeoffs
By investing in assets that are uncorrelated or negatively correlated, investors can enjoy similar expected returns while reducing the risk they are facing.
#2 Long-Term Returns
A good asset allocation strategy can help protect the returns of an investor’s portfolio during periods of heightened volatility, giving them a higher chance of a favorable long-term outcome. This is why your investment horizon should always be part of asset allocation discussion.
How To Do Asset Allocation?
If you are new to investing, asset allocation may appear to be rather complex. You should not be put off by this. To help simplify things, we took an example of how FSM MAPS (My Assisted Portfolio Solution) implements its asset allocation strategy.
As this is a balanced portfolio, there is an allocation of 45% towards fixed income instruments such as Singapore bonds, high yield bonds and global bonds. The remaining 55% of the portfolio is allocated towards equities with Asia, US and Europe equities given the highest allocation.
If an investor selects the MAPS Aggressive (Growth) portfolio, the allocation would be adjusted to 90% equities and 10% bonds, reflecting the higher risk appetite of the investor.
Other portfolio types include conservative, moderately conservative and moderately aggressive. Investors can also aim for either growth or income in their portfolio. You can read up more about the differences in these portfolios here.
The other observation is that asset allocation isn’t just done between asset classes but across geographical regions as well. Key common geographical regions to consider include Asia (excluding Japan), US, Europe, Japan and other emerging markets.
Rebalancing Your Portfolio
Asset allocation isn’t effective unless investors review and rebalance their portfolios at regular intervals.
The rationale behind rebalancing our investment portfolio is that markets do not always move in tandem. During good economic conditions, equities tend to increase in value much quicker than bonds. Investors may thus find their portfolio mix deviating significantly from their original targeted asset allocation levels. During downcycles, bonds may hold their values better than equities, which will also skew investors’ asset allocation levels.
By rebalancing regularly, investors will be able to sell off assets that have increased in (or held) value and to use the funds to make prudent investments that will bring their portfolio asset allocation back to the intended levels.
The chart below is an example from Fundsupermart showing how an annual rebalancing of portfolio can increase an investor’s returns without taking on additional risk.
Source: Fundsupermart – Rebalancing
The result is that by embarking on an annual rebalancing exercise, investors enjoyed a higher return, of 4.1% (10-year annualised), compared to the 2.9% (10-year annualised) return utilising a buy-and-hold strategy. Portfolio volatility is also lower for investors that do an annual rebalancing. You can read up more about the effects of rebalancing on the Fundsupermart website.
Investors who enter different phases in their lives may also have an altered risk appetite. They may wish to review their existing asset allocation at key milestones in their lives to ensure that their portfolio still matches their new investment objectives.
Understand Your Risk Profile And Get Started Today
If you are keen to get started on a prudent investment strategy taking asset allocation into consideration, Fundsupermart (FSM) MAPS is one service you can use.
FSM MAPS allow investors to invest in different portfolios depending on their risk profiles. To find out your unique risk profile, you can complete this online risk profile questionnaire. This takes into consideration your risk tolerance, investment horizon and investment objectives. From there, it suggests the ideal asset allocation mix that could be suitable for you.
You also have the option of investing in the portfolio put forward by FSM MAPS.
Unlike other robo-advisory platforms, FSM MAP doesn’t completely leave the analysis and investment decisions to a predetermined investment algorithm. Rather, its portfolio managers and research analysts study the markets and products available in the market to gain the exposure they desire.
So even though there are elements of robo-advisory at work in areas such as portfolio monitoring and the categorisation of investors within their respective risk profiles, it’s still very much managed by people for the crucial decisions pertaining to the portfolios’ investments.
Regardless of whether you prefer a fund manager to manage your portfolio on your behalf or a do-it-yourself approach towards creating and managing your own portfolio, asset allocation is definitely an area that you should not be ignoring.