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Asset allocation between investment types.

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. David Wolf and David Tulk discuss their asset allocation process for the management of the multi-asset class funds. By harnessing the division of labour, this enables them to actively “tilt” the funds, including along the value vs. growth dimension, all with the goals in mind of adding return and managing risk.

Risk and volatility within the different investment types: a visual

The above asset allocation by account type will minimize the income tax burden upon your investments and maximize your savings flexibility. For additional discussion about account types with their unique characteristics and benefits, visit our section Classroom: So, now that you understand the two different levels of asset allocation, you are now ready to actually begin Step 7 of the portfolio design: Determining your Asset Allocation.

With this in mind, you should begin by assessing the current rates of returns for the basic asset categories Cash and Cash Equivalents, Fixed Income and Growth. Begin with the safest investments first — Cash Equivalents and Fixed Income investments. Start by making a list of the current yields or interest rates offered by money market mutual funds, Guaranteed Investment Certificates GICs , Government Bonds, Corporate Bonds and preferred shares.

This will give you an approximation of the kinds of investment returns available for the first two asset categories. So if your survey has determined that Cash and Cash Equivalents currently generate an average annual rate of return equal to approximately 1.

In the example outlined in Step 5: Calculating your Required Average Annual Rate of Return, we discussed a year old investor that required an average annual rate of return equal to 4. If Fixed Income investments are only offering an average annual rate of return of 5.

But how much of your savings do you allocate to higher risk Growth assets? Finding the right balance between Fixed Income and Growth investments is always a balancing act. At the same time that you want to increase the potential annual rate of return generated by your investments, you also need to minimize your investment risks. Surprisingly, investors do not need to invest the majority of their accumulated savings in Growth assets to achieve a reasonable rate of return with an acceptable level of risk.

For the specific details discussing the balance between asset allocations, rates of returns and volatility, see our section Single Asset vs. If we accept Russell Investments data that demonstrates that Large Capitalized Stocks have earned an average annualized rate of return of All of these would provide greater flexibility in establishing a more conservative asset allocation.

If you are looking at your estimated asset allocation and think it is too conservative, then you may want ask yourself why you want to expose your accumulated savings to greater investment risks than you need to achieve your required rate of return. Proceed to Step 8: Determine your Diversification guidelines. How the game is played! When discussing asset allocation, there are actually two levels of allocation to consider, as outlined below: Three basic investment types Individual investments are typically assigned to one of three basic asset categories: In general, for an individual investment to be assigned to one of the three basic asset categories, each investment must possess certain investment characteristics and features, for example: Cash or Cash Equivalents: For an investment to be classified as Cash or as Cash Equivalen t, the savings are held as a cash balance in an account or it provides a high level of safety for the capital amount, pays a reasonable income while invested, and it can be sold easily at any time or the investment has a very short-term maturity.

As a result, it is classified as Fixed Income for asset allocation purposes. There are many types of assets that may or may not be included in an asset allocation strategy. Allocation among these three provides a starting point.

Usually included are hybrid instruments such as convertible bonds and preferred stocks, counting as a mixture of bonds and stocks. There are several types of asset allocation strategies based on investment goals, risk tolerance, time frames and diversification.

The most common forms of asset allocation are: The primary goal of a strategic asset allocation is to create an asset mix that seeks to provide the optimal balance between expected risk and return for a long-term investment horizon. Dynamic asset allocation is similar to strategic asset allocation in that portfolios are built by allocating to an asset mix that seeks to provide the optimal balance between expected risk and return for a long-term investment horizon.

Tactical asset allocation is a strategy in which an investor takes a more active approach that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for perceived gains. Core-satellite allocation strategies generally contain a 'core' strategic element making up the most significant portion of the portfolio, while applying a dynamic or tactical 'satellite' strategy that makes up a smaller part of the portfolio.

A fund that holds more than one asset class is called an asset allocation fund. This includes many types such as "balanced fund" and so on. In , Gary P. Beebower BHB published a study about asset allocation of 91 large pension funds measured from to The indexed quarterly return were found to be higher than pension plan's actual quarterly return. The two quarterly return series' linear correlation was measured at A follow-up study by Brinson , Singer, and Beebower measured a variance of Also, a small number of asset classes was sufficient for financial planning.

Financial advisors often pointed to this study to support the idea that asset allocation is more important than all other concerns, which the BHB study lumped together as " market timing ".

However, in response to a letter to the editor, Hood noted that the returns series were gross of management fees. Jahnke's main criticism, still undisputed, was that BHB's use of quarterly data dampens the impact of compounding slight portfolio disparities over time, relative to the benchmark.

However, the difference is still 15 basis points hundredths of a percent per quarter; the difference is one of perception, not fact. Ibbotson and Kaplan examined the year return of 94 US balanced mutual funds versus the corresponding indexed returns.

This time, after properly adjusting for the cost of running index funds, the actual returns again failed to beat index returns. The linear correlation between monthly index return series and the actual monthly actual return series was measured at Gary Brinson has expressed his general agreement with the Ibbotson-Kaplan conclusions.

In both studies, it is misleading to make statements such as "asset allocation explains Statman says that strategic asset allocation is movement along the efficient frontier , whereas tactical asset allocation involves movement of the efficient frontier. Hood notes in his review of the material over 20 years, however, that explaining performance over time is possible with the BHB approach but was not the focus of the original paper.

Bekkers, Doeswijk and Lam investigate the diversification benefits for a portfolio by distinguishing ten different investment categories simultaneously in a mean-variance analysis as well as a market portfolio approach. The results suggest that real estate, commodities, and high yield add most value to the traditional asset mix of stocks, bonds, and cash. A study with such a broad coverage of asset classes has not been conducted before, not in the context of determining capital market expectations and performing a mean-variance analysis , neither in assessing the global market portfolio.

Doeswijk, Lam and Swinkels [19] [20] argue that the portfolio of the average investor contains important information for strategic asset allocation purposes. This portfolio shows the relative value of all assets according to the market crowd, which one could interpret as a benchmark or the optimal portfolio for the average investor.

The authors determine the market values of equities, private equity, real estate, high yield bonds, emerging debt, non-government bonds, government bonds, inflation linked bonds, commodities, and hedge funds. For this range of assets, they estimate the invested global market portfolio for the period For the main asset categories equities, real estate, non-government bonds and government bonds they extend the period to Doeswijk, Lam and Swinkels [21] show that the market portfolio realizes a compounded real return of 4.

In the inflationary period from to , the compounded real return of the GMP is 2.

David Wolf and David Tulk

In the inflationary period from to , the compounded real return of the GMP is 2. From Wikipedia, the free encyclopedia.

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In asset allocation planning, the decision on the amount of stocks versus bonds in one's portfolio is a very important decision.

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