Asset allocation is a practice dividing an investor’s resource into various assets, like bonds, stocks, mutual funds, real estate, and private equity. The theory behind this practice is that investors will get a lesser risk if they invest in different classes of assets.
That is because those assets have a different correlation between one and another. For instance, if the stock market rise, usually the bonds fall.
Or else, when the stock market is starting to fall, real estate begins to climb. Thus, investors still have the ability to keep their loss at a minimum level.
Asset Allocation Model
Investors divide their capital for each asset through an asset allocation model. These models reflect the personal risks tolerance and goals of each investor.
Besides, investors can also sub-divide the individual asset class. For instance, if the model tells 40% of the total portfolio to be invested in stocks, then the investors can invest in different field of stocks, like mid-cap, large-cap, or banking.
Types of Asset Allocation Models
Investors can choose the asset allocation models that suit their needs and risk tolerance. Here are the types of asset allocation models.
Preservation Capital
This model is for investors who are going to use their cash in the next twelve months. These investors also do not plan to lose even the smallest percentage principal value.
Usually, these people are people who plan on paying for college, acquiring a business, or buying a house. 80% of this portfolio usually consist of cash and cash equivalents like treasuries, commercial paper, and money market.
The biggest harm from this is that the return has the possibility of not keeping up with inflation.
Income
This model usually consists of fixed income obligation, investment grade, real estate, profitable corporation, and to certain extent shares of blue-chip companies with a long history of dividend payments.
This model is for an investor who wants to get a huge income.
Balanced
This balanced model is between income and growth asset allocation model. Some people think that this balanced model is the best option for their emotions.
This model attempts to compromise between long-term growth and current income. Thus, it generates cash and gets smaller fluctuations than the all-growth portfolio.
Growth
This model is for investors who just start their careers and about to build their long term wealth. This model usually does not generate current income since the owners are mostly employed.
During the bull markets, this model mostly outperforms the other models. Yet, during the bear market, this model gets hit at the hardest.
This model usually central the allocation on the common stocks, alongside the international equity component.
