Asset allocation refers to the act of putting together a portfolio of different types of investments. The goal is typically to achieve a maximum profit on your overall investments and/or to find the right balance in diversifying your investments to minimize the risk of losing money.
Your assets may, for example, be allocated to stocks, government bonds, corporate bonds, real estate, raw materials or currency. The goal is to achieve an optimal selection and balance to match your tolerance for risk.
A range of methods and models designed to assist you in putting together a good portfolio are available. Most of these are based on the modern portfolio theory, which earned Harry M. Markowitz’ a Nobel prize in economics in 1990. Generally, a differentiation is made between strategic and tactical asset allocation.
Strategic asset allocation serves as the basis for the creation and long-term balancing of a portfolio. In strategic asset allocation, the distribution of investment vehicles aligns with your investment goals, investment horizon (the portfolio’s time frame) and primarily, how much or how little risk you want to take on.
Your risk tolerance levels will determine the part of your portfolio made of high-risk investments. The rule of thumb when putting together a portfolio with an investment horizon of at least 10 years is: Secure investments should make up at least 30 percent of your portfolio, while high-risk investments should make up at least 20 percent.
A 50/50 approach is widely used: 50 percent shares and 50 percent bonds. Swiss banks, like most other investment institutions, consider shares to be high-risk investments, while bonds are considered low-risk investments. In recent years though, this logic has been called into question because some kinds of obligations can potentially carry a higher level of risk than shares.
You can rearrange your portfolio at any time. But it’s a good idea to stick to the original proportions you chose for different investment vehicles, to balance out fluctuations in capital markets. Rebalancing your portfolio regularly is recommended. Rebalancing helps you match your portfolio to your current financial situation, including changes that may affect your ability to take on higher-risk investments.
Tactical asset allocation describes short-term modifications to your portfolio and involves shifting the proportions of assets allocated to various investment vehicles within your portfolio. Through tactical allocation, you can adapt the way you invest your assets to match market developments. This lets you take advantage of investment opportunities and (ideally) generate higher profits.
More information:
Swiss Trading comparison tool
Capital Asset Pricing Model (CAPM)
Modern Portfolio Theory (MPT)
Perfect Capital Market
Arbitrage Pricing Theory
Single Index Model (SIM)
Using Fractals To Invest Successfully
