There are many steps in building an investment portfolio, in this article, I’ll discuss how asset allocation and risk tolerance are important considerations when investing.
In simple terms, asset allocation is the mix of all the different types of investments you have in your portfolio. Some examples include U.S. and International stocks, emerging markets, bonds, and real estate. The appropriate mix or recipe in these various categories varies given your age, risk tolerance, and timeline to retirement or spending.
When building a portfolio, it’s important to consider when you will need to start spending the funds. Are you saving for a home down payment in 5 years (mid-term) or socking away funds for retirement in 25 years (long-term). Or do you need funds for your home remodel next year (short term). The shorter the timeline to spend, the more conservative your portfolio should be (less stocks). The longer the timeframe, the higher the percentage can be allocated. The reason for this is that in general, stocks hold more risk in your portfolio. Riskier asset classes of investments provide more potential growth in your portfolio. You don’t want your portfolio to go down if the market corrects just before you need it. That is why we review cash flow, budgets, and goals each time we with clients.
Risk Tolerance is how you feel about the ups and downs in the stock market. The less comfortable with risk, the lower the allocation to stocks. The more comfortable, the higher the allocation. It’s typical for younger investors to have a higher allocation to stocks than retirees, however, if the younger investor has a low-risk tolerance, the “typical” allocation would be different.
Prior to meeting with a client about investments, I like to have them take a short Investor Questionnaire and save a copy of the results. This will get them thinking about their own risk tolerance as we talk about their timeframe, goals, and thoughts on the market and the economy.
I hope you find this helpful. Asset Allocation and Risk Tolerance are two important concepts to consider as you build your investment portfolio.
For a more detailed explanation, review our prior posts: