Portfolio Management - Asset Allocation


What is Asset Allocation?
In simple terms, asset allocation refers to the balance between growth- and income-oriented investments in a portfolio. This allows the investor to take advantage of the risk/reward tradeoff and benefit from both growth and income. Here are the basic steps to asset allocation:

  1. Choosing which asset classes to include (stocks, bonds, money market, real estate, precious metals, etc.)
  2. Selecting the ideal percentage (the target) to allocate to each asset class
  3. Identifying an acceptable range within that target
  4. Diversifying within each asset class

If you are unfamiliar with asset allocation, see the tutorial: Asset Allocation.

In addition, the article Achieving Optimal Asset Allocation contains further pointers on how to appropriately allocate assets to the various asset classes.


Of course, the appropriate mix for a particular client depends upon many of the factors discussed in section 12, including risk tolerance, time horizon and financial goals. For example, an IA with a client who owns commercial real estate properties or a number of rental homes would probably not recommend REITs or other real estate securities in the portfolio.

Risk Tolerance
The client's risk tolerance is the single most important factor in choosing an asset allocation. Most IAs will create a risk-tolerance questionnaire (or use one provided with their financial planning software) to make sure they have an accurate measure of risk. At times, there may be a distinct difference between the risk tolerance of a client and his/her spouse, so care must be taken to reach consensus on how to proceed. Also, risk tolerance may change over time, so it's important to periodically revisit the topic.

Time Horizon
Clearly, the time horizon for each of the client's goals will affect the asset allocation mix. Take the example of a client with a very high tolerance for risk. The recommended allocation to stocks will be much higher for the client's retirement portfolio than for the money being set aside for the college fund of the client's 13-year-old child.

Strategic vs. Tactical Asset Allocation


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