Asset Allocation is a key part to investment risk management.
Many studies show that asset mix is a key determinant of a portfolio’s performance and, the greater the spread between asset class returns, the more important asset allocation is in determining return over time. For example: if the expected return on bonds is 5% and the expected return on equity is 9%, the asset allocation decision between these two asset classes is critical.
Asset allocation is also the key decision in managing the volatility of a portfolio and staying within your own risk tolerance level. One of the best known industry studies determined that, on average, the asset allocation decision accounts for approximately 90% of a portfolio’s volatility over time. While there is debate over the universal acceptance of the specifics of this study for all situations, the fact remains that asset allocation is very important in explaining the volatility (or variability) of a portfolio’s return over time.
Therefore, selecting the right mix of asset classes is a key challenge in investment risk management. A risk management questionnaire can be used as an ideal tool to achieve a balance of diversification by asset class (equities, bonds), investment style, and geography and market capitalization in order to meet individual financial objectives.
The recommended mix determined through Strategic Asset Allocation represents a careful balance between the desires to maximize investment return with the need to control risk. The conflict in these objectives arises because the strategies that offer the greatest prospects for strong returns also tend to reflect the greatest risk. Strategies that offer the greatest safety tend to offer only modest returns. Therefore, Strategic Asset Allocation is the key for Investment Risk Management
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