Investors expect high returns from their investment. They identify and invest in stocks that return the maximum possible returns. However, there are also risks associated with investments. Therefore, they need to manage their risks, as well. There are various investment strategies that they can use to achieve that. Among these strategies, one is asset allocation.
What is Asset Allocation?
Asset allocation is a diversification investment strategy. In this strategy, investors divide their investments among a variety of different types of assets. By doing so, investors can mitigate risks and avoid any large losses in their portfolios. For the purpose of asset allocation, investors can invest in various asset classes. These may include equity, debt, real estate, cash, etc.
Asset allocation allows investors to spread their investments among various assets. It is because each asset class responds differently to any trends in the market. Therefore, having a mixture of different asset classes allows investors to mitigate any losses caused due to one specific asset class. In the absence of an asset allocation strategy, investors are open to higher risks from a specific asset class.
What are the various asset classes?
As mentioned, there are various asset classes from which investors can choose. The most common asset classes, however, are as follows.
Cash is the least risky asset class for investors. However, due to the lower risk, cash also comes with negligible, or often, negative returns. Some of the well-known cash investments are money market funds and certificates of deposits.
Bonds are a type of debt instrument that investors can obtain from various sources. These are a common type of fixed-income investments. Usually, companies issue bonds with higher returns, although they may come with higher risks. The lowest risk bonds are treasury bonds issued by federal governments. State and municipal bonds can also be low-risk options.
Equity is one of the most prominent asset classes. It includes stocks from various countries. As compared to the other options, equity investments are riskier but come with better returns. Investors can select equity instruments based on several criteria, such as returns, risks, type, nature, etc. Investing in equity and stock is relatively easier compared to some of the other options.
Real estate includes investing in property. Real estate is significantly different from the three classes of investments noted above. Investors can either include investment property or real estate investment trust in their portfolio.
Derivatives are another option for an asset class that investors can use. They provide the highest risks and returns.
There are various other commodities that classify as a different asset class in which investors can invest. These come with varying returns.
How do investors use Asset Allocation?
Investors looking to invest a specific amount first determine how they want to split their investment. Based on the decision, they identify various asset classes from the above list in which they can invest. They can further diversify their portfolio by investing in several assets within each asset class. It’s usually best if investors split their investments in a balanced way, so they don’t suffer due to a single asset class.
Asset allocation is an investment strategy that investors use to invest in various asset classes. Through this, they can diversify their portfolio and manage risks better. There are several asset classes from which investors can choose.