Wikipedia of Finance - e-learning course Asset Management Wikipedia Chapter - Asset Allocation – Definition, Strategy, Models, Examples

What is Asset Allocation – Definition, Strategies, Models, Examples


Asset Allocation Definition:

Implementation of an investment tactic that aims to bring the amount of risk involved and the reward in stable equilibrium by well adjusting the proportion of each asset in an investment portfolio with reference to the investor’s risk tolerance, goals and investment time frame. In simple words, disburse of the assets in such a manner that the performing assets or the operating assets are utilized in such a way that they perform optimally and under performing assets are also marginalized, this process is known as asset allocation.

Brief Description on Asset Allocation:

Asset allocation is a significant factor in establishing optimal returns for an investment portfolio. It follows the fundamental principle that different assets behave or perform differently in different market and vary with change in economic conditions.

A basic and simple validation for asset management is the conception that different asset classes proffer returns that are not entirely linked; hence diversification minimizes the entire risk in terms of the unpredictability of returns for a given level of anticipated return. Many asset managers describe asset diversification as “Free lunch you, precisely only free meal one can expect to find in the investment game”. Academic research has meticulously explicated the significance of asset allocation and the setbacks of active management.

Although risk is minimized till the time correspondences are not ideal, it is characteristically anticipate (completely or in part) based on statistical associations (like correlation and variance) that existed over some past period. Expectations for return are regularly derived in the similar way.

Often when such conservative approaches are employed to predict future returns or risks involved by means of the traditional mean-variance optimization approach to asset allocation of modern portfolio theory, indeed the strategy is forecasting potential returns and risks based on history. For it is really uncertain that the past associations, connections or relationships per se will continue in future, this is one of the “weak links” in traditional asset allocation approaches as procured from MPT. Subsequently, there are more subtle weaknesses that include the “butterfly effect”, by which apparently inconsequential errors in predicting lead to recommended allocations that are disgustingly tilted from investment authorized and impractical—often even defying an investment manager’s sensible understanding of a reasonable portfolio-allocation policy.

Asset Allocation Strategy:

Asset allocating strategies are of various types and these are based on various factor investment goals, risk tolerance, time frames and diversification. Three types of asset allocation strategies are

1. Strategic.

2. Tactical.

3. Core-satellite.

1. Strategic Asset Allocations:

The prime purpose of a strategic asset allocation is to generate an asset mix that will offer the most favorable and stable equilibrium between expected risk and return for a long-term investment horizon.

2. Tactical Asset Allocations:

Tactical asset allocation is a technique opted by an investor where he takes a more active approach that attempts to locate a portfolio into those assets, sectors, or individual stocks that illustrate the maximum impending for gains.

3. Core-Satellite Asset Allocations:

You can understand core satellite asset allocation is more or less a hybrid mixture of both the strategic and tactical allocations mentioned above. Another prominent approach which depends on three basic assumptions is Systematic Asset Allocation. The following assumptions are as follows –

The first one is all the explicit information about the available returns is provided by the market. Then the second assumption on which systematic asset allocation is that the relative expected returns reflect consensus. Final assumption of the approach is expected returns provide clues to actual returns.

Asset Allocation Models:

Many investors does not think before taking decisions. But there are many investors who adopt asset allocation model based on two categories (bonds and stocks) and investment risk. This risk type asset allocation model has greater impact on your portfolio performance. Let us look into some of the common types of asset allocation model examples which will guide towards risk upon return strategic models.

Asset Management Model – 1Asset Management Model – 2Asset Management Model – 3
Age: Often 18-35Age: Often 35-55Age: Often 55+
Type: Short / Long-TermType: Mid-TermType: Short-Term
Asset Allocated ModelAsset Allocated ModelAsset Allocated Model
10% Fixed Income30% Fixed Income50% Fixed Income
90% Diversified Stock70% Diversified Stock50% Diversified Stock
Model Features:Model Features:Model Features:
Growth: HighGrowth: ModerateGrowth: Low
Income: HighIncome: ModerateIncome: Low-Moderate
Risk: HighRisk: ModerateRisk: Low
Average Growth: 13%Average Growth: 11%Average Growth: 9%
Expected Portfolio ReturnsExpected Portfolio ReturnsExpected Portfolio Returns
1 yr: 12.0%1 yr: 11.0%1 yr: 8.5%
5 yrs: 14.0%5 yrs: 13.0%5 yrs: 10.0%
10 yrs: 17.3%10 yrs: 15.0%10 yrs: 11.5%

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