Portfolio diversification remains the cornerstone of sound investing. Today’s tech-driven and hyperconnected world provides approaches beyond traditional asset allocation. In the digital age, new tools and platforms offer investors unprecedented opportunities. Through greater access and information availability, investing has opened up to all ages and markets as it never has before.
Exclusivity in finance is a thing of the past. Anyone with an internet connection, sufficient interest, and initiative can easily create a diversified portfolio and allocate assets. Financial experts have lost the monopoly on strategic investing, and we are in a new era of economic democratization and inclusivity.
Given these opportunities, how does one get started on asset allocation? Asset allocation involves distributing investments across asset classes like real estate, stocks, bonds, cash equivalents, and alternatives. The premise behind this approach is to balance risk and return, knowing that each asset class has its degrees of risk and return potential. By judiciously selecting different investment vehicles and assets, investors can achieve growth in their investments as they mitigate risk.
Even the most sophisticated investors find it extremely difficult to time the markets. For the ordinary investor, asset allocation beats market timing and security selection by a wide margin. Because big wins are hard to predict, focusing on “time in the market” rather than market timing is better. Time in the market predicts long-term success better than narrowly focused buys or trades.
The fintech revolution of recent years has made asset allocation much more accessible for beginner investors. Robo-advisors, the ubiquity of investing information, and online tools are now empowering a new wave of investors to create diversified portfolios customized to their financial goals and needs and tailored to their risk tolerance.
Here, we review a list of online tools to help novices in asset allocation and building a well-balanced portfolio.
Automated Portfolio Management With Robo-Advisors
While the term sounds intimidating for novice investors, a robo-advisor is, at its core, an automation tool that helps you select your investments based on your needs and preferences. Robo-advisors are algorithm-driven and use mathematical models to help you construct and manage a portfolio with less time and effort.
They consider your time horizon, risk tolerance, financial goals, and capital invested and decide on your behalf. Robo-advisors are an efficient option if you want to diversify your investments but need more time or expertise to research or decide strategically on your allocations.
Vanguard Personal Advisor Services, Wealthfront, and Betterment are all examples of robo-advisors that help streamline the asset allocation process. As an investor, you are made to answer questions about your personal goals and constraints. These are factored into your diversified portfolio, which is often a mix of mutual funds and low-cost Exchange-Traded Funds or ETFs.
Investment Apps: Revolutionizing Investment Access
Among younger investors, especially millennials and GenZ, investment apps like Stash, Acorns, and Robinhood are top-of-mind. The generation that uses TikTok as among its primary sources for personal financial advice also uses apps to allocate its capital and invest in digital assets.
Investment apps provide new ways to invest. For example, users get access to fractional shares of ETFs and stocks. This feature makes retail investing more affordable and open to a broad audience.
While investment apps are easy to use and offer greater flexibility, they have limitations. Investment apps tend to be specialized or limited to certain products. In addition, some of them have a gamified UX/UI design that may increase impulsive trading among their users. Before you sign up on these platforms, it is advisable to have a planned asset allocation approach in mind to avoid getting caught up in impulsive decisions.
How To Allocate Assets Effectively
There are ways to maximize growth while ensuring your portfolio is well-allocated and risk-mitigated. The following are essential strategies for effective asset allocation:
Asset class diversification
Many seasoned investors rely on diversification across asset classes to manage risk. Capital is ideally distributed across real estate, stocks, bonds, and other assets with varying degrees of risk to balance returns with stability. For example, stocks have been proven to offer higher returns but are also known to be volatile. Bonds, on the other hand, provide income stability but yield modest returns. In the long term, a well-diversified portfolio can weather different economic scenarios. Balanced portfolios hold up well during recessions and profit from times of aggressive growth.
Diversification by sector and geography
Apart from diversifying by asset class, another way to look at investments is to segment them by sector and geographic location. The globalized economy poses new risks, and geographic diversification may help reduce risk from any region. By dividing investments by area, you can mitigate risks associated with regionally-associated geopolitical events and economic downturns.
You can also divide your investments by sector. When building an equity portfolio, you can divide your investments among stocks historically deemed recession-proof, such as healthcare, and those profited from market optimism, such as technology stocks.
Investing in Defensive Stocks
One crucial category worth highlighting is defensive stocks. They are traditional safe havens that even billionaires depend on, regardless of the economic environment.
Defensive stocks are not just for weathering recessions. Even in optimistic environments, defensive and safe haven assets are there to hedge against unexpected risks and volatility in the market. They also offer an alternative to gold, which has recently delivered unimpressive returns after the successive rate hikes that battered financial markets.
Evergreen sectors, on the other hand, performed strongly in 2022. Defensive companies like Coca-Cola, UnitedHealth, and Johnson & Johnson are examples of those that fit this category. Elite hedge funds favor these stocks because they pay constant dividends and still have the potential for growth because of products and growth catalysts within their companies that make them resistant to recession environments or downturns.
Defensive ETFs are also a no-brainer option for some investors. In the market, conviction, if any, has been concentrated among areas considered defensive. Even when the economy is emerging from recession risk, defensive companies still present excellent value propositions and strong fundamentals.
Long-term investors look to defensive stocks for protection and higher long-term averages. Valuation is essential, as is growth capability and financial strength. Other examples of defensive sectors include utilities, consumer staples, and energy.
Regular portfolio rebalancing
As an investor, assuming that the financial landscape is constant or that your investment will present the same risk and growth profile in a decade as it did today is dangerous. Given the dynamics of the economy, it is essential to review your portfolio periodically and adjust your asset allocation according to your financial needs, life events, shifts in the economy, or unexpected events.
Rather than view asset allocation as a one-time decision, see it as a constantly evolving scenario sensitive to market movements, economic events, and other factors. Trends and fluctuations in the market may cause your asset allocation to drift from your original goals. When this happens, you must adjust your portfolio to fit the desired percentages and risk profiles.
New online tools help you with decision-making and can automate the rebalancing process. You can use them judiciously to align your investments with your overall strategy. Nonetheless, being utterly passive about your investments is not advisable, even with these intelligent tools.
Customization according to risk tolerance
Every investor has their own risk profile. Before diving into any risk allocation, one should know one’s risk tolerance. If you need help gauging your investment risk tolerance, you can use questionnaires and self-assessment tools from online robo-advisors and brokerage platforms. These free and widely available tools can help you get familiar with your willingness to withstand market volatility.
Once you get comfortable with your risk tolerance level, you can move forward with your asset allocation decisions and apply the above strategies more confidently.
Asset Allocation Models
Now that we’ve learned the basics of effective asset allocation, we can move on to models and techniques that help fine-tune asset selection and portfolio rebalancing. Among these are:
Constant-weighting of assets
Constant-weighting asset allocation can be applied as you continually rebalance your portfolio. If an asset declines in value, this strategy requires that you purchase more of that asset. If its asset value increases, you would sell some of it. This strategy ensures that it retains the same weight in your portfolio as you initially designed.
The rule of thumb behind this technique is to rebalance your portfolio to its original mix whenever any asset class moves beyond 5% of its initial value.
Strategic allocation of assets
Strategic asset allocation is a strategy that helps decide the percentage of a portfolio to be invested in stocks, bonds, cash, or other asset classes. The decided percentages and proportional combinations of assets are based on the target rate of return for each, the time horizon, and the investor’s risk tolerance.
Once the percentages or allocations are decided, the investor sticks with the formula for an extended period, typically several years. You can then review your portfolio periodically and rebalance it as needed.
Strategic asset allocation aims to take a more passive approach to investing. It’s akin to a buy-and-hold strategy advocated by many long-term investors for certain assets. This investment technique also relies on diversification to manage risk—the proportion of assets is carefully aligned to the investor’s tolerable level of risk.
It is a traditional approach based on Modern Portfolio Theory (MPT). MPT argues that markets are efficient. Therefore, they follow more reliable patterns than individual human investors’ decisions. The market’s built-in efficiency over time is why MPT calls for a fixed set of assets, a balanced portfolio, and steady allocations.
To illustrate, an investor with a high risk tolerance and low time preference could allocate 70% invested in stocks, 20% in bonds, and 10% in cash. Another approach that caters to a medium risk tolerance is a breakdown of 60% stocks and 40% bonds. These models can be referred to as the 70/20/10 and the 60/40 portfolios.
As a rule, aggressive approaches allocate more toward stocks, and conservative methods allocate more to bonds.
Tactical asset allocation
Tactical asset allocation involves a more active approach towards investing versus strategic asset allocation. Some investors might find strategic asset allocation too rigid over the long run. Making tactical deviations from the original mix is reasonable to capitalize on new trends or exceptional opportunities.
With tactical asset allocation, you gain flexibility and add a market-timing component to your portfolio, which allows you to adapt to economic climates that favor some asset classes over others. Moreover, this may be ideal for a changed time horizon influenced by new circumstances.
Tactical asset allocation is a moderately active approach towards investing. The portfolio reverts to the overall strategic asset mix as soon as the short-term objectives are accomplished. However, tactical asset allocation needs the investor’s discipline, knowledge, and skill. You need to recognize the opportunity and then decide when it has run its course, after which you revert and rebalance to your previous long-term position.
Dynamic asset allocation
Dynamic asset allocation is the complete opposite of the constant-weighting strategy. With this model, the mix of assets is constantly adjusted based on the fluctuations of markets or on the strengths and weaknesses of the economy. The investor is always watching which assets decline and which increase and acts accordingly by selling those that drop and buying those on the rise.
Rather than approaching a portfolio based on a constant mix or target percentage allocation, it heavily relies on the investor’s or portfolio manager’s assessment of market events and asset value.
Insured asset allocation
When you adopt an insured asset allocation strategy, you decide on a base portfolio value. The portfolio must not drop below this value under any circumstances.
Should the portfolio drop to base value, you focus on risk-free assets. You buy treasuries, preferably T-bills, to fix or anchor the base value of your portfolio. It is wise to consult a highly qualified financial advisor for advice on reallocating assets best and even review your entire investment strategy.
However, if the portfolio returns above the base value, you can actively manage it. With ample and reliable information, you can decide on the securities to hold, buy, or sell. Active management is aimed at increasing the portfolio value.
Risk-averse investors who desire high security with some flexibility will want to establish a guaranteed floor. With the insured asset allocation model, investors can exercise a level of active portfolio management while enjoying a minimum standard of living based on the base value.
Integrated asset allocation
Integrated asset allocation considers various aspects of the models mentioned previously. It accounts for expectations and shifts in capital markets, integrating risk tolerance into the mix.
The integrated asset allocation model involves a broader approach to asset allocation strategy. While the other techniques mentioned consider future market returns in their expectations, not all factor in the investor’s risk tolerance. Hence, risk tolerance is baked into the highly adaptive integrated asset allocation model. However, you must choose between constant-weighting and dynamic asset allocation, as both cannot coexist in the same portfolio management strategy.
Tracking Investment Performance: App Features To Look For
How do you know if your asset allocation strategy is working? You need information, and what better way to access it than new technology? Investment apps today provide features that help you monitor investments in real-time as your portfolio might include any mix of assets, including stocks, mutual funds, bonds, ETFs, 401(k)s, and individual retirement accounts or IRAs, having all these assets in one or a few dashboards saves time. It compresses information to help you make better decisions faster.
Some apps help you track your entire net worth in the palm of your hand. Others allow you to create a savings plan and sync multiple accounts. With ample financial data, such apps can track your investment performance, the fees you’ve incurred, and your current asset allocation in user-friendly graphs.
Look for investment review features that help assess whether you are underweight or overweight in a particular sector. This service enables you to reallocate assets if you are over-invested or crossing your risk threshold. Find apps that help you establish benchmarks, like the S&P 500 index, to help you gauge whether you’re doing well or slacking off. Furthermore, choose apps that compare your performance versus major ETFs, market indices, and mutual fund positions.
These features help you gauge the effectiveness of your asset allocation strategy and, thus, are crucial in implementing the asset allocation models listed above. Automated monitoring and reporting allow you to examine your investment decisions and their outcomes in detail against your desired targets.
Moreover, you also become aware of your investment costs, which include account fees, transfer charges, trading commissions, and mutual fund fees, and help you decide on the most effective way to save money.
Apply What You’ve Learned: Start Allocating Assets Online
You can get started on asset allocation and online investing by signing up for a new online brokerage account. Online brokerage accounts are specialized financial accounts that let you invest in different asset classes. They allow the convenience of tracking your investments on a laptop or mobile device, free of human advisors such as those you would encounter from a typical full-service brokerage.
To find the right online broker, you must assess a broker’s platform for cost, account types, and trading platform design because some apps favor buy-and-hold investors, while others are developed for more active traders. Popular apps today offer retirement accounts, custodial accounts, and taxable brokerage accounts, making them flexible for any user aiming to save for retirement or simply seeking greater financial stability.
You must also review the types of securities available on the brokerage platform, as not all are created equal in this respect. Many have limitations on the types of assets offered. Some, for example, offer stocks but not bonds or mutual funds. Have a strategy in place before you sign up.
Above all, information is vital, and a platform’s dedication to providing accurate information to its users is an excellent sign. Several highly-rated investment apps offer their customers a combination of third-party and proprietary research. Use this information to empower you and enhance your asset allocation strategy to meet your goals.
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Featured Image Credit: Photo by Brett Jordan; Pexels; Thank you!
