Asset allocation is simply the distribution of your investment assets across the spectrum of asset classes.
For example, you may be invested equally in stocks, bonds, certificates of deposit, and gold coins. In this case, your asset allocation is:
- 25% stocks
- 25% bonds
- 25% cash
- 25% precious metals
You can get as granular as you want because there are subclasses or categories of every asset class. For example, equity ETFs and mutual funds can be US stocks or international stocks. Or they can be large cap, mid-cap, or small cap. Or they can be growth, value, or blend. Or they can be focused on a specific industry sector, like technology, communications, or utilities. As I write this, my investments are spread among 20 different equity asset categories and four different bond asset categories.
Morningstar splits mutual funds and ETFs into more than 100 categories! (People quibble about which ones are truly asset classes versus which ones are categories of subclasses.)
Target Asset Allocation
Whether you intend to or not, your portfolio has an allocation that is defined by the types of investments you hold. But the key for most investors is to determine a target asset allocation for their portfolio, and then invest according to that target. As they invest more money, they invest so that they maintain their desired allocation. And from time to time they rebalance their holdings in order to re-achieve their target allocation.
There is no one correct target asset allocation. If fact, your target likely will change over time. An individual’s target asset allocation (aka target portfolio) is usually based on any number of factors, including:
- investment horizon (how long until you need the money)
- risk tolerance
- risk capacity
- investment choices available (e.g., if your only investment vehicle is your company’s 401(k) plan, then you have limited options)
The White Coat Investor has catalogued more than 200 target portfolios!
The point of having a target asset allocation is to keep yourself from investing willy-nilly, and instead stick to an investment program that is designed to achieve your investment goals.
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