Asset Allocation

A new era of investing has begun. The times of high interest rates and high inflation are behind us. The times when we could blindly invest in indexes and expect superior returns are also gone. Instead, this new investment environment requires a more sophisticated, active approach to generating attractive returns and controlling risk. This approach is asset allocation.

What Is Asset Allocation?
Asset allocation is a method for determining what mix of investments is likely to produce the best returns at any time. The idea is to invest in the right blend among stocks, bonds, and cash–and to adjust the mix as market conditions change. For example, a growth portfolio might be invested 70% in stocks, 20% in bonds, and 10% in cash equivalents (money-market funds). If the market outlook for stocks deteriorated, the mix might shift to 50% stocks, 30% bonds, and 20% cash.

Why Is Asset Allocation Important?
Many studies have been done to analyze the impact of asset allocation on investment portfolios. For example, a study performed by Brinson, Hood and Beebower in 1986 found that over ten years, 90% of the difference in returns among a group of large pension plans resulted from decisions about the asset mix, rather than from security selection. Such studies indicate that getting the asset mix right is the most important part of successful investing.

In 1988, the Nobel Prize in Economics went to Harry Markowitz and others, who developed a statistical model called the Capital Asset Pricing Model (CAPM). The CAPM indicates that a mix of stocks and bonds can provide significantly higher returns, with less risk, than an all-bond portfolio. The CAPM also indicates that while the long-term return of a mix of stocks and bonds is not as high as the return of an all-stock portfolio, the risk and volatility of a blend of stocks and bonds is substantially lower than with a pure stock portfolio.

Asset allocation seeks to improve on a static blend by making strategic shifts among asset classes–to create the optimal balance between return and risk.

Ongoing Discipline
Successful asset allocation involves looking at the market as a whole and evaluating a wide variety of indicators to determine which types of investments are most attractive. Investor psychology, monetary conditions, and market valuation all combine to produce a complete outlook for the market.

Psychological and monetary indicators are used to determine where investors are going and which assets are likely to perform best. The market valuation tells the expected magnitude of any move in the markets.

How Can You Use Asset Allocation?
You can implement asset allocation in your own portfolio in several different ways. Custom asset-allocation recommendations are available for individual clients to identify a mix of stocks, bonds, cash, even international securities, that fits their goals and objectives. An investment professional trained in providing asset-allocation advice should be consulted.

Emily S Hazlett is Vice-President:Investments at ENB Insurance Agency, Inc. a wholly owned subsidiary of Evans National Bank.

Our firm does not provide legal or tax advice. Be sure to consult with your own tax and legal advisors before taking any action that would have tax consequences.

Asset allocation/investment timing cannot eliminate the risk of fluctuating prices and uncertain returns.