Asset allocation strategically builds a portfolio to create market exposure with a mixture of investable instruments across different asset classes. Asset allocation seeks to distribute funds in a portfolio to various investment types to generate a reasonable return on risk based on an investor’s time horizon, financial goals, and risk tolerance.
The main investable asset classes include equities, fixed income, commodities, alternative investments, and cash. Each offers varying degrees of risk and are critical components of a well-balanced, diversified portfolio.
Riskier assets, like equities, tend to have higher returns but are more volatile. Safer investments include bonds and money markets, which are typically less volatile but often generate lower returns.
Equities are shares issued by small-, medium-, and large-cap domestic companies and include corporations from international and emerging markets.
Commodities are naturally produced goods traded through an exchange, such as energy, metals, lumber, meat, and agriculture. Commodities are subject to external forces, such as weather, and can be risky in unstable market conditions.
Corporate bonds and Treasury securities are fixed-income instruments that are typically less risky than commodities and stocks. They are backed by the creditworthiness and assets of large corporations and governments. Bonds provide current income through interest payments and the potential for appreciation.
Alternative investments are financial assets that are not regulated or traded on exchanges and are typically illiquid, like art or real estate.
Cash is a staple of any portfolio. While it does not generate any returns beyond interest, it is a safe way to have reserves available for emergencies and investment opportunities.
The percentage of a portfolio allocated to each asset class can be tailored to meet specific investment objectives.
For example, a younger investor with a long time horizon may choose to invest in more volatile assets, such as stocks or commodities, with the intention of holding those assets for a long period of time, regardless of intermittent drawdowns to the account. Investors with a short time horizon may choose to invest in safer assets like bonds because they do not want to hold through market downturns.