4 steps to effective asset allocation

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Once you have assessed your risk tolerance and determined your time horizon, you can establish the mix of cash, fixed income and equities that is appropriate for you.

When you have the right mix of cash, fixed income and equities, you can feel confident that your portfolio can provide the security, liquidity, cash flow and growth potential to meet your current needs while you build wealth over the long term. The following steps provide a basic framework that can help you determine and maintain your optimal asset allocation.

1. Assess your risk tolerance. How comfortable are you with market volatility? During the stock market downturn of the past year and a half, many investors discovered that their tolerance for risk was much lower than they had thought.

2. Determine your investment time horizon. On a long-term basis, equities have historically outperformed cash and fixed-income investments. If you’re willing and able to stay invested for the long term (say, 10 years or more), the better chance you have to ride out equity market volatility.

3. Set targets. Based on what you learned in the first two steps, you can establish the mix of cash (for security and liquidity), fixed income (for stability and cash flow) and equities (for growth) that is appropriate for you.

4. Rebalance to stay on track. Over time, your portfolio’s asset allocation can change as a result of uneven asset-class performance. For example, if equities have a very strong year, your equity asset allocation may rise to a point that exceeds your comfort level with volatility. Your time horizon and risk tolerance are also subject to change.

It’s important to review your asset allocation on a regular basis. If it’s no longer appropriate, you can rebalance either by buying and selling assets within your existing portfolio or directing new cash infusions to underweighted areas. Our Portfolio Planner tool can help you determine your investor profile, including your risk tolerance and time horizon.