Mention asset allocation to most casual investors on the street and the typical reply is usually something along the lines of "asset what?"  Surprisingly, this basic starting point for most portfolio positions could be the single largest determining factor of your long-run investing success.  Who knew asset allocation could be so important?

If your own asset allocation model looks something like this you are not alone.

Image credit: Ryan Harne

Let's face it - asset allocation discussions are boring.  It's not exciting cocktail party conversation, and it's a lot more exciting to talk about that hot stock tip you got into last week (even if its not panning out quite as you hoped).  Unfortunately, many necessary items in life are boring to deal with, but eventually need to be dealt with to get things done properly.  We'll try to make this as painless as possible and cover off the very least you need to know about asset allocation, and how to get started on the right path.

So what is Asset Allocation anyways?

Asset allocation is simply the division of portfolio investments into different asset classes in such a way to reduce portfolio risk and to enhance long-term risk-adjusted returns for a particular individual needs. The key takeaway here is that an asset allocation strategy that works for one individual many not work for another.

Determining Your Own Asset Allocation Strategy

We don't have enough time or expertise here to cover off all you need to know about determining your own asset allocation strategy, but we will highlight some of the key areas you need to be prepared to discuss with an experienced financial planner. Creating an asset allocation strategy is like finding clothes that fit you and match your own unique style. Its not a one-size fits all approach. Here are some things to consider:

What are your liquidity needs?

What is your risk tolerance?

What are your return aspirations?

What is your investment time horizon?

Do you have tax considerations?

Do you have unique circumstances?

What are your income needs?

What are your financial goals?

What is our starting level of wealth?

What are your life goals?

When do you plan to retire?

What are your intergenerational wealth transfer plans?

Developing an Asset Allocation Strategy Starts with an Inward Look

As you can see there are many variables that come into play for someone to develop an asset allocation strategy that is a fit to their own unique financial position. Developing an asset allocation strategy is critical to your long run investing success and should not be overlooked. Meeting with an experienced and credible financial planner can help you develop a solid asset allocation strategy. We always recommend people approach "fee-only" financial planners to reduce the chance of biased recommendations that could be influenced by compensation incentives. Resist the urge to approach "free" financial plans, and pay the money upfront for professional advice. This is one area you do not want to screw up.

Asset Allocation Accounts for 93.6% of Investment Performance!

Yes, you read that correctly - 93.6% of your investment performance will be determined by the asset allocation strategy you develop. In 1996 a landmark study by Brinson, Hood and Beebower titled "Determinants of Portfolio Performance" that was published in the Financial Analysts Journal concluded that asset allocation is the primary determinant in investment performance, and security selection and other factors determined only a small portion of investment performance.

Freedom 55 or Eating Cat Food?

Your asset allocation strategy is paramount to your investment performance over the long-run. Get it right and you could be retiring from the rat race ahead of plan and in style. Get it wrong and you could be working a lot longer and eating cat food during retirement? In our next report on asset allocation we will be exploring how to construct a portfolio selecting the best opportunities in each investment class, and how you can manage your own portfolio for maximum returns.

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