This month we have a look at Asset Allocation – and how to make it work for you

If you have been investing for a while, you’ve probably heard the term asset allocation. It’s considered to be one of the most important decisions an investor will make, and one of the most important factors of investment success. So what is it? Most investments fall into one of these basic categories – cash, fixed income, and equity. Asset allocation is basically how you allocate assets to those categories to best balance risk and reward.

There is no simple formula that can determine the right asset allocation for everyone. Every investor has their own unique risk tolerance, which differs from that of other investors. Every investor should also have their own asset allocation strategy based on their tolerance for risk, their financial goals and their investment timeline.

Establishing clarity in these areas is critical to ensuring that your investments are suitable for you. Based on differences in perception and experience, people have different views on risk, and what risk means to them. For example, I have a client who came to Canada while her parents were living in a war-torn country. At the time, she kept large cash reserves in case she needed to help them. Today, although they are no longer living, she still feels the need to keep a large balance in cash. This gives her a sense of security, which is more important to her than making more money by investing. Financial goals and time horizon also have to be well understood, and a good advisor will probe deep enough to get a true sense of what all these things mean to you.

So now that we’ve touched on the value of effective asset allocation – let’s see how we can take traditional asset allocation one step further via an investment strategy known as dynamic asset allocation.

Asset allocation is based on the principle that different assets perform differently in different market and economic conditions, and therefore diversification reduces the overall risk.

Dynamic asset allocation takes asset allocation to another level. It involves evaluating current market conditions and deciding whether or not to rebalance. By continuously analyzing the global financial market, investment managers can uncover opportunities that show the most potential for gain.

The primary aim of such an investment is to reduce the impact of shorter-term market fluctuations. This provides a smoother ride and less volatility. An example of how dynamic asset allocation can be advantageous, can be seen in the case of my client, Daniella. As a long time investor who wasn’t bothered by market volatility and who strived for high investment returns, Daniella preferred to have a high equity component in her portfolio. In discussing the importance of asset allocation, and dynamic asset allocation, she agreed to include a reasonable fixed income portion to her portfolio. This turned into a strategic opportunity when the stock market dropped unexpectedly. With equities prices low, we felt it was a good opportunity to buy equities. We agreed to use some of her fixed income allocation to buy equities while they were “on sale”. As the equity markets regained ground, Daniella made a nice profit on this strategic opportunity.

Generally, a dynamic investment solution might be for you if you are looking to have a more active management approach to your investments and/or have an expert portfolio management team taking care of day-to-day investment decisions. And, depending on the portfolio you choose, you may be able to obtain tax-efficient income from your investments now or in the future, and/or defer income tax on your investment. There are many different product options in the market place that use dynamic asset allocation; your advisor can help you to find the one that best suits you.

Establishing a clear asset allocation strategy is critical to having a successful investment plan. Adding the benefits of dynamic asset allocation can help to reduce volatility and increase return. Clearly understanding your risk tolerance, your financial goals, and your time horizon is the foundation to developing a strong investment plan. If these factors aren’t well defined for you, then discuss your financial situation with an advisor, who can help you to analyze where you stand on them – and where to go from there.

Lynn MacNeil, F.PL. is a licensed Financial Planner with Investors Group Financial Services Inc. in Montreal, with 20 years experience working with retirees & pre-retirees. This column is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide legal advice. For a private financial consultation, or more information on this topic or on any other investment or financial matter, please contact Lynn MacNeil at (514) 693-3384 or [email protected]

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