Introduction
Asset Allocation is one of the sub-categories in trade risk management. Investors from traditional and DeFi crypto markets can use them to improve their trading strategy and mitigate the probability of losses.
What is Asset Allocation?
Asset allocation is a type of investment strategy. It is the method of dividing the investment budget across various asset classes such as securities, bonds, and cash. There are various types of investment products available in a region at any given time.
Each type of asset class or investment option is influenced by different market factors and carries varied levels of risk. Asset allocation is done based on various factors that are specific to an investor’s goals and requirements.
Relevant Terms to Asset Allocation
Here are some popular terms that are used when reading about asset allocation. To understand the concept better, it is best to learn about their meaning:
Diversification
Diversification is often used as a synonym for asset allocation. However, the two terms are distinguishable from each other. Diversification is about spreading your portfolio among various variants within a singular type of asset class such as cryptocurrencies.
On the other hand, allocation means investing in various types of asset classes such as equities and cash equivalents etc.
Rebalancing
Rebalancing is a process of bringing the investment portfolio back to its original mix. It is done based on the rate of increment in a given asset class. For example, investors held 60% of stocks at the start but later increased their stock positions to 80%.
To make the most of the market movement, he is bound to sell some of his stocks to increase stakes in the biggest gainers. It is best to keep track of trading fees and taxes when rebalancing.
Time-Horizon
Time-Horizon is the amount of time that defines the complete trading goals. It is the unit that represents the intended hours, days, weeks, months, or years that an investor intends to hold a given trading position.
Risk Appetite
Risk appetite or tolerance is the number of financial losses that an investor can sustain without any major financial damage. The investors can also view this as their willingness to lose some of the investment to obtain bigger gains later.
How does Asset Allocation Work?
Here are some of the important aspects to consider when finalizing an appropriate asset allocation strategy:
Strategic Asset Allocation
Strategic Asset Allocation is usually done to rebalance the current trading portfolio. A person who is investing to finance their mortgage payment may consider options like cash, certificate of deposits, and treasury bills.
Meanwhile, a person who is investing for retirement may allocate their savings in Individual retirement accounts or IRAs. The risk appetite of the investor shapes the overall strategic asset allocation.
Age-based Asset Allocation
Age-based Asset allocation is about determining the appropriate ratio of savings to allocate. In most cases, investors subtract their age by 100 to find out the percentage of savings invested in stocks.
As a general rule, investors are bound to hold stocks for five years before taking profits. There are also exceptions where investors may minus their age from 110 or 120 to find the correct investment ratio.
Life-Cycle Funds
Mutual Funds are sometimes referred to as life-cycle funds or target-date funds in the context of Asset allocation. They allow investors to maintain portfolio structure based on their risk appetite, age, and investment objectives.
However, some financial experts do not agree with this method of investing on account of standardized solutions.
What is an Asset Allocation Fund?
An asset allocation fund is a type of investment option that offers investors a diversified investment basket. This fund contains assets hailing from various asset classes.
Depending on the asset allocation strategy of the fund manager, the proportion and ratio of the alternative asset classes within the funds can vary or remain fixed.
Conclusion
When it comes to investing, sticking with only one type of trading instrument can be a problem. To reduce risk, investors should consider asset allocation. However, it is important to understand the variable factors affecting different asset classes and learn to perform due diligence before incorporating this strategy.
