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How’s your asset allocation looking these days? And your diversification?
- Asset allocation, simply put, is how you’ve divided your savings among different investment classes. Typically, the major division is between stocks and bonds, but other types of investment areas like commodities, real estate, and even collectibles, can be involved too.
- Diversification is how you’ve spread your holdings within those classes. For example, an investor can have a mix of growth stocks and value stocks within their overall stock portfolio.
Sometimes people use the terms interchangeably, although they do have distinct meanings. Nevertheless, the idea of mixing investment types to help protect against loss is the important point.
Why the mix is important
If you’re a stock market junkie or perhaps even just a mildly active investor, you probably keep tabs on the asset allocation and diversification in your portfolio most of the time. But if you shy away from 401(k) statements or sidestep making decisions about savings plans, you might not.
And that might not be a wise thing at times.
The stock market can go up or down — and often does. It set new records here and there in the past decade while generally advancing well beyond the market troughs of the early to mid-2000s. But political and international uncertainties — not to mention unforeseen crises like a pandemic, a spike in inflation, and even a war — rock it periodically.
When that happens worries begin to surface about whether or not stock market pullbacks will linger.
Market retreats: Who gets hurt?
Pullbacks, obviously, affect all investors. But such retreats are particularly concerning for those people approaching retirement and expecting their stock portfolios to help support them through their Golden Years. Younger investors have time to recover from market losses; older investors, not so much.
That’s why most money managers and financial professionals preach the wisdom of asset allocation and diversification, the investment equivalents of not putting all your eggs in one basket.
Connect with a MassMutual financial professional
Although there are no guarantees, spreading investments out over a variety of asset classes in addition to stocks — like bonds, commodities, real estate, and, yes, even annuities (admittedly including MassMutual products) — can help preserve value in a portfolio should the equity markets take a tumble.
Then again, when one market takes off, investments in other areas may limit a portfolio’s advance. Indeed, in any advancing market there will be pundits saying a correction may come there and others saying the gains will likely continue and investors shouldn’t miss out. No one can be sure and for each individual investor the question revolves around how much risk he or she is willing to accept. (Know your risk profile?)
Asset allocation, then diversification
This is where asset allocation and diversification comes into play. Asset allocation is the overall strategy of dividing a portfolio among different asset classes, stocks, bonds, and other areas. Diversification is the tactical move of choosing different investments within those classes.
How asset allocation works. The proper overall mix of investments — stocks, bonds, and other areas — will not be the same from investor to investor.
- An older investor may want more of his or her portfolio in less volatile investments, perhaps bonds, in order to safeguard retirement savings.
- Those investors with a longer time horizon may be willing to accept a little more volatility and risk in exchange for the possibility of greater gains over time. And so, they may prefer to look at putting more money into equity investments.
- And some investors may opt for ground in-between, putting a portion of their money into risky areas while channeling some into more stable markets and vehicles that will build steady value over time.
How diversification works. The investment mix within a portion of a portfolio will differ from person to person as well and depend on factors like his or her time horizon, financial circumstances, goals, and personal disposition toward risk and reward.
Indeed, each asset class can have a range of investments within it offering different levels of risk and possible reward. Stocks range from relatively risky entrepreneurial startups to long-established enterprises. Bonds can also range from relatively risky corporate debt to government debt that has long been viewed as the bedrock of markets, like U.S. Treasurys.
Remember to change over time
The proper asset allocation for a particular person will change over time, as they get older or their tax status and investment goals change. Also, new investment opportunities may become available. Cryptocurrency, for example, is a growing investment class. (Related: Should crypto be in your portfolio?)
That’s why many investors revisit their asset allocation on a regular basis and look for new opportunities to expand their overall holdings and diversify the actual investments within them.
Depending on the situation or complexity, some people opt to consult a financial professional or other expert to review their asset allocation, diversification, and investment mix.
So, how’s your asset allocation? And are you diversified within those allocations?
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Frequently Asked Questions about asset allocation and diversification
Q. What is the difference between asset allocation and diversification?
A. Asset allocation divides your money across different asset classes, like stocks and bonds, to balance risk. Diversification spreads your investments within those specific classes, such as owning both technology and healthcare stocks.
Q. Why is asset allocation important for my portfolio?
A. It helps balance risk and reward according to your specific financial goals and timeline. A well-allocated portfolio can help cushion the blow during unexpected market downturns, protecting your hard-earned savings.
Q. How often should I review my asset allocation?
A. You should review your investment mix at least annually or whenever you experience a major life event. Periodic rebalancing ensures your portfolio stays aligned with your long-term goals.
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Discover more from MassMutual...
The power of perspective in turbulent times
Understanding dollar-cost averaging
Setting financial goals: Income
This article was originally published in June 2017. It has been updated.
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Asset allocation does not guarantee a profit or protect against loss in declining markets. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio or that diversification among asset classes will reduce risk.
