How Asset Allocation Can Help Manage Risk?
There are assets like stocks, funds, bonds, real estate, gold, foreign exchange, and cash.
Then how should investors allocate these assets?
There are two principles to consider.
The first rule of thumb is to manage your portfolio's overall risk and choose less correlated assets. This is to spread the risk. The second principle is to help seek greater potential returns and look for assets that may provide higher medium and long-term returns.
It's like planting a tree. To make it thrive, you need more than just favorable soil conditions.
A quality seedling with better growth potential is also key to your success.
Let's look at the first principle.
Asset correlation measures how different assets move about each other.
To reduce your portfolio correlation, you need to consider both the correlation among different asset classes
(e.g. stocks, bonds, and cash) and the correlation within the same asset class (e.g. large-cap stocks, mid-cap stocks, international stocks).
For example, when stocks shrink, equity funds may fall as well. So these two different types of assets
within the same asset class are still highly correlated.
During the interest rate hike cycles, the performance of stock funds may not be so good, while the yields of money market funds are on the rise.
The two belong to the same type of assets, but their correlation is relatively low.
At the same time, the correlation of assets is not static.
For example, during a recession, when stocks fall, the risk-haven gold may rise.
But in a US rate hike, when the stock prices come under pressure, a strong US dollar will also keep the gold price controlled.
Therefore, when allocating assets, choose less correlated assets, and adjust your portfolio to different situations accordingly.
Let's move on to the second principle, look for assets that may provide higher medium and long-term returns.
Investing is for making money. Apart from lowering portfolio risks, achieving returns matters, too.
Therefore, assets with a greater potential to generate returns should be considered.
Some assets have better performance in the long run.
For example, stocks of companies with growing businesses and strong profitability may fall in an economic downturn. But in the long term, they have historically recovered. Funds managed by excellent fund managers generally can weather an economic downturn and seek a return over the long term.
Some assets, in certain market conditions, will typically perform better.
For example, in the early stages of urbanization, property prices may soar;
During a recession or inflation, the price of gold often rises;
When the domestic currency depreciates, foreign currencies held can bring some benefits.
Therefore, when allocating assets to increase overall portfolio return, you’d better take into account your risk tolerance, consider assets with better long-term profit potential, and flexibly fine-tune your portfolio according to market changes.
Let's go over the principles of asset allocation we mentioned.
First, reduce asset correlation to manage risks; second, consider giving priority to assets with greater potential to generate higher returns after taking into account your financial situation and risk tolerance.
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
