Understanding asset allocation for your portfolio

Asset allocation is the investment in the major financial asset classes that reflects the investor’s risk return profile. The investment objectives for most are to protect their principal and generate decent returns. The three major asset classes in an investment portfolio are cash, bonds and stocks. Depending on the investor’s particular needs, the asset mix will likely be dominated by one of the three financial assets. Cash refers to short-term investments. They include money in bank or stockbroker accounts and bank issued term deposits. Bonds are debts with terms longer than one year. Stocks represent units of ownership in a publicly traded company.

The investor’s risk-return profile determines the asset allocation mix. For example, the investor nearing retirement would have predominantly high quality bonds in their portfolio. Their main investment objectives are preservation of capital and steady income. Ideal bond holdings are those issued by governments and corporations with high credit ratings.

For the younger investor, someone who is just starting their career, their investment portfolio is more weighted towards stocks. Equities offer the highest returns over the long run. It is also the most risky. A young individual has sufficient time to ride out the volatility associated with the stock market. As the individual approaches retirement age, more of their portfolio holdings will be shifted towards bonds. Wealth preservation becomes more important than growth.