Apparently, there are more than 43 quintillion combinations of a Rubik’s Cube, but only one solution. This is very much like the asset allocation question. Of all the possible combinations of assets, which mix is right for you? How do you go about determining your unique blend?
Solving the Cube and Allocating Your Investments
Research says that a portfolio’s return is almost totally defined by its asset allocation.1 In the parlance of Rubik’s Cube, that means the way you arrange each of the pieces makes all the difference. But solving the investment puzzle has a special twist.
While there is only one way to solve Rubik’s Cube, there is an unlimited of ways to organize your assets. And like the puzzle, there is still only one correct solution: yours!
But there’s another spin on asset allocation. Whatever mix you arrive at needs to stick. You could move the pieces around whenever you want. If you do, however, you risk messing up your long-term results.
Asset allocation is one of your most important long-term investment planning decisions. It really needs to be durable. It’s best not to change it until your financial circumstances change (e.g., you achieve a wealth goal, you retire, etc.). It’s strategic, not tactical.
So, getting it right could give you an advantage meeting your future consumption goals. Getting it wrong could cost you your most important financial planning objectives.
How Asset Allocation Works
Asset allocation means mixing together investments that are risky (like stocks) with less risky ones (like bonds and cash) to try to reach an expected return or to reduce risk.
Adjusting the mix makes it possible for you to strike a balance between risk and return.
Risk and Expected Return
There is a tradeoff between risk and return. Assets with high expected returns typically come with high levels of risk. Assets that deliver lower returns generally present you with less risk.
These individual asset characteristics influence a portfolio’s overall risk and return potential based on how much of each is in the mix.
In other words, the proportion of stocks, bonds and cash defines a portfolio’s expected range of risk and return.
A portfolio with a high expected rate of return inherently comes with greater risk. To reduce that risk, you’d add lower-risk assets. Doing this will also lower the portfolio’s expected return.
For example, if you have a high tolerance for investment risk and are shooting for as high a rate of return as you can, then you might own a lot of risky assets, like stocks.
If you have a low risk tolerance and would be okay with lower returns, then a portfolio of mostly bonds might be more suitable for you.
Like the Rubik’s Cube, there’s a whole universe of possible asset allocations out there. And each of them can be plotted on a risk-return continuum. People on one end of that continuum might be characterized as “Aggressive” investors. Those on the other might be labeled “Risk Averse.”
Finding the Right Blend
People who master the patterns of the Rubik’s Cube can solve it in about 10 seconds. They see through the quintillions of possibilities and maneuver exactly where they’re supposed to be.
There are nearly as many investment possibilities. And we can help you with questions you have about which solutions might make sense.
Contact us now!
We’re available at (800) 235-8396.
1 Roger G. Ibbotson & Paul D. Kaplan, (2020) Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?, Financial Analysts Journal, 56:1, Pgs. 26-33, January 2, 2019.
