Investment Portfolio: Asset Allocation and Risk Tolerance

Investment Portfolio: Asset Allocation and Risk Tolerance

An investor would not be able to achieve success without a well-made investment portfolio. Pulling off a perfect performance through market timing or just by selecting frontrunners does not exist.

However, creating a strong portfolio opens the door to success. It also helps the investor avoid market volatility-related concerns.

See more: Volatility Trading: What is it?

Successfully building an investment portfolio mean following these steps:

Identifying the right asset allocation

 

Asset AllocationStep 1

 

The very first thing in creating a portfolio is to determine the financial state and goals. Asset allocation is a way to help balance portfolio risks and rewards.

In building a portfolio, the age, the time required to raise the investments, how much capital will be needed to invest, and future income necessities are some of the factors that must be taken into consideration.

An investor must choose the asset classes and subclasses he would like to use. That may include cash, fixed income, equities, and alternatives, such as real estate and commodities.

Step 2

The next step will be to find out the size needed for each basket. After that, the baskets can then be filled with specific investments, including stocks, bonds, cash equivalents, real estate investment trusts (REITs), and commodity index funds.

Asset allocation baskets have the tendency to overflow. For this reason, it is important to rebalance them from time to time. Baskets that are under-filled can also be used to reallocate excesses.

Systematically selling high and buying low can help investors stay true to their asset allocation, and create larger returns in the long term.    

Assessing risk tolerance

Step 1

Investors must know their risk tolerance based on their own profile. They can be the conservative type or the aggressive one.

The more risk the investor can tolerate, the more aggressive the portfolio will be. This would then offer a bigger space for equities and less to bonds, and other fixed-income securities. On the other hand, the less risk investors will be able to bear, the more conservative their portfolio will be.      

Step 2

There is no such thing as a risk-free investment. All investments come with some risk in them, but the level of risk can differ. Investors may choose a high-risk investment or a low-risk investment.

The potential for higher returns comes at the price of greater risk of losses. Riskier assets, such as small-cap or emerging market stocks usually generate larger returns over time. However, the swings can be hostile. Hence, investors must have a basis for dividing their riskiest holdings from their less risky ones.

Learn more: Several Types of Investment Risks    

It is also important to choose a mix of investments that can offer the biggest possible return at the level of risk they are comfortable with. Moreover, an investor who knows his risk tolerance would also help answer the question as to how the investments should be distributed among various asset classes.

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