Executing a saving plan often comes to a point where one has to think about the portfolio management and allocation. Investment portfolio reflects the personal values. This means that some people value risk when others are more favorable towards safety. Also, the economic environment can reflect portfolio allocation. The main idea in asset allocation is that different asset classes perform differently in different economic conditions.Managing investment risk and return factors are done by diversifying the investment portfolio in multiple different asset classes. There are 3 traditional asset classes: stocks, bonds, and cash. There is also other classes like commodities and real estate (REIT).
I will list 3 different investment portfolio asset allocation strategies that I have been using.
Fixed assets strategy
Some don’t want to spend time on tinkering the numbers and have better things to do. In this model, the idea is to have a more passive asset allocation, that needs less looking after. Everything starts from a policy that forms the base structure of the portfolio.
Main things to take consideration are personal age and risk / return profile. If a person is young and investment horizon is long, there is more room for risk and possible higher returns. Elder people are more likely to have less volatile and safer investment portfolio, due to shorter investment horizon. The risk tolerance is another factor that affects asset allocation. Some people are fine in the high-risk environment when other can’t get sleep if investments are not doing well.
When investment horizon and risk factors are evaluated next step is to form policy. In the high-risk investment, portfolio weight is on the stocks. The low-risk portfolio is based more on bonds and cash. The idea is that portfolio asset allocation is based on policy and is managed passively, only to be reviewed occasionally.
An investor can calculate the possible return for a combination of different asset classes by calculating historical returns from the all the asset classes together, to estimate the total return of the portfolio.
Constant-Weighting asset strategy
This is an active asset allocation strategy based on the idea of constant balance of different asset classes. If one of the asset classes show weak or strong performance the investor actively balances the portfolio to back to the planned structure.
Let’s say that one asset class on the portion performs weakly. The investor puts the weight of the new investments to the weak asset class to be able to balance the portfolio. Stronger asset classes in the portfolio don’t get new investments or the funds are moved to the weakest asset class.
The benefit of this strategy can be seen as “buy cheap sell high method”. The asset class that has weak performance can be seen as a cheaper investment option compared to other better performing, more expensive asset classes in the portfolio. This strategy also benefits from the market cycles and trends of different market environments.
Dynamic asset strategy
The idea of this portfolio asset strategy is to actively manage the balance of the portfolio depending on the markets. Investor tries to read the markets, predict the movements and make the portfolio adapt the current and future trends. To predict the markets investor can use tools as technical analysis or the “Investment Clock”.
For example, if the stock markets show weakness and there has been a long upstream trend, the investor sells stocks avoiding further decreases. In another hand, if the stock market is showing signs of strength, the investor buys stocks to benefit from coming market trend.
In my opinion, the dynamic asset strategy may involve risk. The short term trends are hard to predict, or almost impossible. What if the prediction goes wrong or the possible market movement is shorter than expected. Transaction cost can reverse the outcome so that investor doesn’t benefit from active management.