One of the best ways for investors to diversify their portfolio is through something called asset allocation. It’s an investing strategy that calls for you to spread your money across different asset classes such as bonds, stocks, real estate and more, thus diversifying your portfolio and curtailing risk. But as straightforward as that might sound, it’s not as easy to master due to how frequently assets can ebb and flow. So, how can you be successful at this strategy?
The best way to approach asset allocation is to think of it in terms of driving in some of the country’s worst traffic, according to CEO of oXYGen Financial, Ted Jenkin. Here are his tips for understanding the important issue of diversifying your portfolio with asset allocation.
Asset Classes Are Like Driving Lanes
Consider that each lane represents an asset class that moves as its one pace. That asset class can be bonds, cash or another type of asset.
Asset Classes Can Change Pace at Any Time
If one traffic lane — or asset class — begins to slow down, your natural urge might be to move your car to the fastest-moving lane across the highway. In terms of investing, this means moving your money to the seemingly better and well-performing asset so that you can catch a return faster. But this can often be a premature and futile move, according to Jenkin.
“What will happen is that we often make a knee-jerk reaction, and this knee-jerk reaction is that when my lane starts going slow — in this case, it’s international or it’s bonds or it’s cash — then I’m going to switch everything over to U.S. equities. By the time you do that other lanes are going to start to move faster.”
As a rule of investing, it is best to “buy things when they’re low — when they’re stopped,” Jenkin said. Therefore, it might pay to stick to that slower-moving asset class.
Impulsive Mistakes Can Happen
Out of frustration, you might make some careless mistakes on the road, and the same can be said in asset allocation.
“What happens if you hit the brake and you stop too hard in traffic, does this mean you immediately say to yourself, ‘Oh no, emerging markets are doing terrible, now it’s time for me to sell that asset,” Jenkin said. “And then next year, the year after, emerging markets are doing 40, 50 return, and you’re going to kick yourself for stopping on those brakes too hard and shifting out of that asset class.”
Think before you make big moves in order to avoid more mistakes.
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