Home' Trinidad and Tobago Guardian : October 5th 2014 Contents As investors, we have an over-
whelming number of stocks,
bonds and mutual funds to
choose from. However, con-
trary to what some might
think, security selection not
the only key to building successful investment
portfolios. Such a strategy can easily imperil
your investment aspirations and create stress.
The consensus among most financial pro-
fessionals is that asset allocation is one of the
most important decisions that investors can
make to affect their portfolio performance. A
study by landmark Brinson, Hood and Bee-
bower, "Determinants of Portfolio Perform-
ance" (1986, 1991) argues that asset allocation
accounts for 94 per cent of the performance
of a portfolio, leaving market timing and stock
selection to account for only 6.0 per cent.
Given that asset allocation is so important
to performance, let us attempt to clearly define
it. Asset allocation is an investment strategy
that attempts to balance risk versus reward
by dividing the portfolio s assets based on the
investor s risk tolerance, goals and investment
time frame. In other words, your selection of
individual stocks or bonds is secondary to the
way you allocate your assets to equities, fixed
income instruments and cash.
Asset allocation is very important to an
investment strategy as different asset classes
offer different returns and they are not all
correlated. This means that if you invested
say 80 per cent of your portfolio in Asset Class
A and 20 per cent in Asset Class B, whereas
someone else invested 50 per cent in A and
50 per cent in B, and Asset Class A performed
twice as well as B, then simply by putting
more in the better-performing asset class you
would have significantly outperformed.
How do you select the right asset allocation
for you? Here are some questions you may
want to consider: Have I prioritised my primary
financial goals? What s my investment time-
frame? How much fluctuation in the value of
my investments can I handle?
Some financial advisers offer a simple strat-
egy where you minus your age from 100, and
this should be how much you should have
invested in equities and the rest should be
invested in fixed income and cash. However,
there are many more factors that should impact
your personal asset allocation. We will highlight
three main factors that should help you select
the right asset allocation.
Your personal goals and objectives
Whether you want to retire at fifty or build
your dream home next year, it should be fac-
tored in to your asset allocation strategy. Ulti-
mately, if your goals are mostly long-term, or
longer than five to ten years, then you can
invest more into equities as your portfolio has
the time to ride out short-term fluctuations
in the stock market.
However, if your goals are more immediate
in nature, such as within the next three to five
years, then your portfolio should be invested
more heavily in fixed income and cash, which
are not as volatile.
Your risk profile
Your asset allocation should be governed
by your risk-return trade-off. The risk-return
trade-off means that low levels of uncertainty
or low risk are associated with low potential
returns, whereas high levels of uncertainty, or
high-risk are associated with high potential
Thus, investors with a higher risk tolerance
should typically allocate more money into rel-
atively riskier assets. However, if you cannot
sleep at night when those markets are fluc-
tuating and gyrating, then you should have a
higher proportion invested in fixed income,
even if you are in your 20s.
Don't put all eggs in one basket
A key factor in investments is diversification
that can provide the right mix of risk versus
return. The broader your diversification, the
more favourable your balance between risk
and return and must be factored into each
investor s portfolio.
By investing in more than one asset category,
the Unit Trust reduces the risk to your portfolio
and can mitigate losses. If one asset category s
investment return falls, the investor will be in
a position to counteract their losses in that
asset category with better investment returns
in another asset category.
By not putting all your eggs in one basket,
we are able to limit losses and reduce the fluc-
tuations of investment returns.
One can develop an asset allocation strategy
that meets your investment appetite. In a
strategic allocation, you establish and adhere
to a definite asset allocation based on the long-
term returns you expect for each asset.
In tactical, you may occasionally engage in
short-term, tactical deviations from the set
asset allocation in order to capitalise on unusual
or exceptional investment opportunities.
With a dynamic strategy, you constantly
adjust the mix of assets as markets rise and
fall and the economy strengthens and weakens.
Choosing which strategy to adapt depends
heavily on your level of expertise when it
comes to investing.
Tactical and dynamic asset allocation strate-
gies involve anticipating and reacting to market
movements, which means that you would
need to be consistently monitoring the capital
markets and interpreting the impact of these
movements on your portfolio.
Investors are faced with a plethora of options
on where to put new money, which is often
an overwhelming situation.
Choosing how much to allocate between
equities, fixed income, and cash, as well as
making investment choices, affects the ability
to achieve your investment objectives. Suc-
cessful, rational investors excel because of a
clear methodology, and discipline which can
be easily developed with the use of an asset
allocation strategy. Individual investors require
individual solutions and there is no one stan-
dardised solution for allocating your assets.
Once you have determined your goals and
objectives for investing, your risk tolerance
and your comfort level with investing, you are
on your way to building a portfolio that is
right for you.
Determining what risk level is most appro-
priate for any investor isn t found in any for-
mula. Risk tolerance differs from person to
person and your decision will depend on your
goals, whether short, medium or long-term,
financial condition and life situation.
Log on to www.ttutc.com for more infor-
mation. Do you have any questions or com-
ments about this column? Are there any
topics that you would like covered ? Please
e-mail us at email@example.com
What is your asset
Choosing which strategy to adapt depends heavily on your level of
expertise when it comes to investing.
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt OCTOBER 5 • 2014
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