The Role of Asset Allocation in Wealth Management

Understanding asset allocation is important as a cornerstone of wealth management, even if you are not managing your portfolio personally.

Apr 27, 2023|Market Insights- 4 min

Asset allocation aims to select asset classes that work together to maximize returns and minimize risk.

This article covers the basics (see our educational series featuring David Darst for more details).

Defining “Return” and “Risk”

Return is simply what you get back from the amount you invested. If the returns are stretched over a long period, you may need to consider inflation to calculate your real return.

Risk refers to the chance that you might lose some or all the money you invested. Investments with a high potential return often carry a higher risk of loss.

Understanding asset classes

Asset classes are logical groupings of investments. Four main asset classes are:

Cash and equivalents: Cash is typically held in a bank or in ultra-low-risk investments such as government bonds. It earns a low return but has a near-zero risk of loss. It is also easily accessible.

Bonds: Bondholders are entitled to interest payments during the life of the bond and the return of the invested principal at maturity. Although the upside is limited, some recovery is likely if the company goes bankrupt.

Stocks: A stock is a share of ownership in a company. If the company does well, dividends may be paid, and the share price can appreciate considerably. If the company goes bankrupt, shareholders could be left with nothing.

Alternative Investments: This covers various assets such as private equity, art, commodities, and real estate. While some can be risky, they often behave differently compared to the overall market, which is helpful for diversification (see below).

The importance of diversification and rebalancing

All asset classes have benefits and drawbacks. Asset allocation is about combining asset classes for an optimal outcome.

An effective asset allocation achieves a diversified portfolio of assets that do not rise and fall in unison. Diversification is achieved by investing across asset classes, industry sectors, company sizes and geographical locations.

As the value of asset classes change over time, your asset class mix may become concentrated in one asset class. Rebalancing your portfolio periodically will bring it in line with your target asset allocation (see our separate articles on diversification and rebalancing).

Tailoring asset allocation according to investor needs

Just as no single asset class performs well in all market conditions, no single asset allocation suits all investors.

An asset allocation should consider the specific individual’s circumstances, including:

Goals: While a long-term view of investing is generally a good idea, near-term goals (e.g. buying a house, children’s education) need to be reflected in the portfolio and may require keeping a certain percentage of the portfolio in cash.

Timeline: Younger investors have a higher appetite for risk, as they have time to recoup any losses that arise. Older investors with shorter horizons and no employment income may need lower-risk allocations.

360 view of investor assets: A portfolio must consider the investor’s other assets. If an investor owns a farm, for example, the portfolio may need investments that are counter-cyclical to the agricultural businesses (i.e. diversification).

Refining your allocation

Asset allocation does not end with a customized, well-diversified portfolio that is rebalanced periodically.

Structural market changes may also require changes in the asset allocation strategy. For example, in a low-interest rate environment, stocks tend to offer more optimal returns than bonds. If interest rates rise, the allocation may need to be adjusted to include more bonds.

Changes in personal circumstances—such as increases/ decreases in income, marriage or the birth of a child—can also affect timelines and liquidity requirements which need to be reflected in the asset allocation strategy.

A qualified financial advisor helps you create and maintain an effective strategy and adjust it when necessary.


About The Family Office

Since 2004, The Family Office has been the wealth manager of choice for more than 500 ultra-high-net worth families and individuals, helping them preserve and growth their wealth through customized solutions in diversified alternatives and more. Schedule a call with our financial experts and learn more about our wealth management process.

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