Investment portfolios: Asset allocation models

Before you consider the different allocation models, it's important to understand what an investment portfolio is. An investment portfolio is a collection of investments held by an individual or institution. Portfolios can include a variety of different assets, such as stocks, bonds, cash, and real estate. The goal of an investment portfolio is to generate returns over time, while also managing risk.. 

Link to Vanguard article on portfolio allocation

Suggested portfolio for age groups

The above portfolio for age groups is also available in google sheets. The sheet format permits you to adjust the "rule of number" to give you more flexibility based on your risk. As stated in the portfolio for age groups article, some financial planners suggest a more aggressive approach.

Link to google sheet - please make a copy to edit

Asset Allocation and diversification

Asset allocation and diversification are two crucial strategies in investing. Asset allocation involves distributing your investment portfolio across different asset classes like stocks, bonds, and cash. Diversification, on the other hand, spreads investments within and across asset classes, aiming to reduce risk and potentially enhance returns.

Diversification

It's about spreading your investments within and across different asset classes to reduce the impact of any single investment's performance on your overall portfolio. For instance, within the stock market, diversification can involve investing in various sectors (technology, healthcare, etc.), company sizes (large-cap, small-cap), and geographic regions (US, international)

Both asset allocation and diversification help manage risk, potentially leading to more stable returns over the long term. A well-diversified portfolio can help protect against significant losses if one or more investments underperform.

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Understanding how to build a resilient investment portfolio is crucial for long-term financial success. A powerful tool to illustrate this is an Asset Return Map, often presented as a chart that visually displays the annual performance of various asset classes, ranked from best to worst, over many years.

What this map reveals is the dramatic and unpredictable shifts in asset class rankings from year to year. No single asset class remains at the top indefinitely, and last year's winner can easily become this year's laggard. This volatility underscores the inherent challenge of consistently picking winning investments.

This is precisely why diversification is important. By spreading your investments across a variety of asset classes—such as stocks, bonds, real estate, etc. —you increase your chances of investment success. A diversified portfolio aims to mitigate risk by ensuring that if one asset class underperforms, others may be performing well, thus smoothing out overall returns and providing greater stability. Instead of trying to guess which individual asset class will be the best each year, diversification helps you capture returns from a broader range of market conditions, ultimately enhancing your long-term financial goals.

Rebalancing

As markets fluctuate, the allocation of your portfolio may drift from your intended target. It is recommended to periodically  rebalance your portfolio to align with your risk tolerance and investment goals. 

Example 

Asset Allocation: "60/40" portfolio, where 60% of the portfolio is allocated to stocks (higher growth potential, higher risk) and 40% to bonds (lower growth potential, lower risk) is a common example of asset allocation. 

Diversification: Investing in an S&P 500 index fund (diversified across many large US companies) or a Total Stock marker fund (or ETF) is an example of diversification within the stock market. Holding a mix of stocks, bonds, and potentially other assets like real estate funds or ETF is a good way to diversified your portfolio.