Grouping these different asset classes into a collection, or portfolio of assets is called asset allocation. It’s the process of deciding how much of your money should be allocated to which asset – how much in shares, bonds, property or cash?
Of the amount in shares, how much is in UK shares, or US, or European? Of the amount in US shares, how much should be in big companies and small companies? That’s asset allocation at work – it’s the CHOICE about how much goes where. This is going to be a huge oversimplification, but hopefully it’s helpful.
The Assets to Think About
Cash is an asset for spending only. It also serves a purpose for being defensive, so if you’re worried about investing, you might hold more cash than normal, but this is generally not a good idea for too long. It’s also an opportunistic holding – having cash on hand you can put into other assts quickly if an opportunity arises.
Equities are primarily about growth. If you want money to grow, you should have a high allocation to equities. But equities can be volatile, so you also need to give an equity holding time to grow and to iron out those ups and downs on the way up. Investing in equities over short timescales is risky, and not good investment doctrine.
Bonds are more about income, so if you’re retired, you might have a larger bond holding than someone who’s 35 and growing their money. Bonds are also a risk mitigator, so they can balance equities out to reduce the risk of the whole.
Property is also about growth and very much about leverage, as discussed earlier. It’s about tangibility, which may people prefer, but its illiquidity can be a problem. You can’t move money around quickly, or sell a property overnight, whereas you could easily do that with an equity or bond holding.
Alternatives are generally diversifiers. They often behave differently to the other asset classes, and so will go some way to reducing the risk of the portfolio as a whole. They carry their own risks though, so I tend never to recommend more than 10-15% of any portfolio to be held in alternatives and usually quite a lot less than that.
Someone with large spending needs in the short term should hold more cash. Someone looking to grow money over a long period of time should hold more equities, but someone with the same investing timescale but who’s more worried about risk should hold fewer equities and more bonds, perhaps. People with liquid wealth and the capacity for risk and leverage should own property, perhaps alongside their equity and bond portfolio.
You see? Each blend of assets, each portfolio is unique, and can be constructed according to the needs, timescales, risk tolerance and other factors which are unique to that investor. But I don’t believe it’s possible to identify a ‘correct’ asset allocation – there’s no perfect blend of assets for each individual investor. Well, there is, but that can only be seen in hindsight, which isn’t much use.
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