What is Asset Allocation?

There is a well-documented language barrier in the investment world that intentionally or unintentionally keeps people out.  We believe that great client experiences include user friendly language for better understanding and more satisfying conversations.  Asset allocation is one of the "basics" and is the recipe for your investing strategy.

What is Asset Allocation?

Let’s start at the beginning.  What is an asset allocation?  Investopedia defines asset allocation as an investment strategy that aims to balance risk and reward (return) by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. 

An easy way to think about asset allocation is to picture a pie chart.  Each “slice” represents a different asset “class”, i.e. stocks, bonds, cash.  Each asset class has a different level of expected return as well as expected level of risk.  In other words, each slice has a different job to do within the portfolio.  The higher the expected return the higher the expected level of risk and vice versa. The “blend” of assets within the pie is what determines the overall risk and reward.  The more conservative the portfolio, the less it is impacted by market ups and downs and the smaller the reward.

• Stocks = equities (company ownership), 
• Bonds = fixed income (a bond represents debt and the fixed income is the interest rate or coupon, the company, country, or city may pay to borrow funds.)  
• Cash = cash and can be held in money market funds, certificates of deposit.  For purposes of this discussion we will set banking accounts to the side, even though they hold “cash” for this purpose are not considered part of the asset allocation.
• Real Estate = generally in the form of REIT’s (a real estate investment trust) REITs are corporations that own and manage a portfolio of real estate properties and mortgages.

The recipe for this particular pie includes the “slices” listed above.  Your financial advisor at Mosaic Fi will determine your blend or asset allocation after thoroughly understanding your goals, time frame, comfort level with investing, tax considerations and perhaps your need for income.  Having a  financial plan prepared in advance of investing is an excellent way to identify these parameters.

Within each slice there may be mutual funds representing various industries,  geography (international vs domestic), company size (small, midsize, large), and style (growth vs value).  The investment advisor first determines the overall pie and then how much to allocate within each slice.  Finally, they will select the individual investments that fit within each pie slice.

Why is Asset Allocation important?

A client’s asset allocation is going to have a large influence on the overall performance of their investment portfolio.  Ensuring that the asset allocation properly reflects their unique set of circumstances is what will allow the portfolio to maximize growth with the appropriate amount of risk. If the asset allocation is too conservative, then the client may miss out on higher returns they could have received and if the asset allocation is too aggressive, then the client may panic when the markets are going down and want to pull their money out at the wrong time. 

It also holds the investment advisor accountable for performance.  If a portfolio’s performance deviates from the agreed upon asset allocation, the client should be given an explanation for that circumstance.  With all Mosaic Fi clients, an Investment Policy Statement (IPS) is signed so that the advisor and client attest to being on the same page.  If there is an intentional change to the IPS, a new one should be prepared and executed.

Do Asset Allocations Change?

 A client’s asset allocation can change based on a change to the client’s circumstances and needs, or if their comfort level changes.  To effectively make changes, a detailed conversation about the particulars of the change is discussed between the client and their advisor.  The consequences of a shift in asset allocation need to be fully outlined by the advisor and understood by the client.  Sometimes there are tax implications and often there is a change to the expected return and risk for the portfolio. There may also be an increase or decrease in the income the portfolio produces.

An asset allocation is one of the most critical factors of an investment strategy for our clients.  It is what helps determine the “sleep at night” factor.  Recent market fluctuations illustrate the importance of a well-designed asset allocation that is providing our clients with confidence and comfort that the inevitable storms will be weathered well.