You are likely to earn positive returns in the long run when you invest and stay invested.
But when markets fluctuate, they may tempt you to make financial decisions in reaction to the changes in your portfolio.
People who base their decisions on emotion often end up buying when prices are high and selling when they’re low. They ultimately find it extremely difficult to reach their long-term financial goals.
So how can you protect yourself from making these common investment mistakes?
Let’s dive in to discuss the strategies 70trades use to help you reduce risks associated with investing and potentially earn more consistent returns over time.
Asset allocation refers to how you spread assets in your portfolio to meet a specific objective. It’s an investment strategy that aims to balance risk – rewards by apportioning assets based on your individual goals.
It takes into consideration your goals, risk appetite, and how long you aim to maintain your portfolio before selling.
Asset allocation may be the single most important factor in your success.
Let me give you an example.
Let’s say your goal is to grow your portfolio and you don’t mind taking on market risks to achieve your goal.
You may decide to place even 80% of your assets in stocks and 20% in bonds.
However, always know your investment timeframe and possible risks and rewards of each asset class before you decide how to divide asset classes in your portfolio.
Major asset classes have the following risks and reward:
Bonds – An investor lends money to the bond issuer in exchange for interest payments.
- Lower market risk since short-term price fluctuations are less severe.
- Preserve your principal capital, but they tend to have lower long-term returns. They also have higher inflation risk over time.
- Bond prices are likely to fall when interest rates drop. So, if you sell your bond before it matures, then you’re likely to get a lower or higher price than you paid depending on the direction of interest rates.
Stocks – They represent a company’s ownership share. Companies issue stocks as a way to raise money to invest in their businesses. Investors buy stocks to grow their money and outpace inflation over time.
- They carry high level of market risk in the short term due to market fluctuations.
- Potentially earn higher long-term returns and outpace inflation more than any other asset.
Money market instruments – They include treasury bills, deposits, commercial papers, certificates of deposit, bills of exchange, bankers’ acceptances, repurchase agreements, federal funds, short-lived mortgage, and asset-backed securities.
- Money markets carry low risk and most stable among other assets.
- Lacks the potential to outpace inflation by a large margin.
- Federal Deposit Insurance Corporation or any other government agency does not insure or guarantee them.
So, we have seen different asset classes offer varying levels of potential return and market risks.
70trades uses asset allocation to optimize your risk and return by investing in a mix of assets. They ensure your choice of assets has a low correlation to each other. They will also weight your portfolio towards more volatile investments if you are more aggressive.
Having said that, asset allocation doesn’t work in isolation. It’s closely related to portfolio diversification.
Portfolio diversification involves selecting a variety of investment asset classes to help protect you from investment risks. Diversification helps lessen the effects of a major market swing on your portfolio.
Portfolio diversification and asset allocation work together.
How does portfolio diversification work?
Let’s say you wanted to invest in a stock of one company. That means you’d be taking on a bigger risk by relying solely on that company’s performance to grow your portfolio.
It’s also known as a single security risk – the risk that your investment’s value will fluctuate widely with the price of one holding.
But, what if you decide to buy stocks in 10 or 15 companies in different industries? You will substantially reduce the potential loss with market fluctuations. A return on one investment might be falling but rising on the other-which helps offset the poor performer.
Remember, we said in asset allocation your choice of assets must have a low correlation to each other.
Similarly, portfolio diversification means holding a variety of non-related assets to eliminate unsystematic-risk. It means owning a large number of assets in different industries and companies.
Before we wrap up, building a portfolio is a delicate process. You need to consider your options carefully before you choose.
70trades’ Portfolio Builder is a tool designed to help you better understand the risk and return drivers of a portfolio. It helps you make a better and balanced portfolio to suit your trading goals.
Asset allocation and diversification for long-term investing
I have a few questions for you:
- Do you have a personalized portfolio?
- Have you diversified your investments effectively to align with your specific goals?
- Which asset classes make more sense to your financial goals?
- Are you comfortable with the amount of risk and return in your portfolio?
70trades can help you answer these questions and provide personalized recommendations.