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3 Tests to Determine Your Asset Allocation Thumbnail

3 Tests to Determine Your Asset Allocation

The asset allocation decision is one of the most important decisions that you will make when setting up your investment portfolio.

In order to make good asset allocation decisions, you need to properly assess yourself as an investor in these key areas:

1️⃣ Your Ability To Take Risk

How long is your time horizon? How stable is your income? Do you need to access the portfolio for liquidity? Do you have a "Plan B" in the event that the portfolio goes down at the same time as you need funds?

2️⃣ Your Willingness to Take Risk

This is the "stomach acid test". Or, the point that your portfolio goes down enough that you scream "GET ME OUT".

Stocks have been a great way to build wealth and preserve purchasing power, historically. But, they are orders of magnitude more volatile than safe bonds and cash.

A global index portfolio of equities went down by over 1/3 in the spring of 2020. An index portfolio of US equities went down by over half in the Great Financial Crisis. 🤢

If you can't imagine seeing your portfolio dropping that far, that is an important data point. You should consider balancing your portfolio with safe bonds or cash.

3️⃣ Your Need to Take Risk

If you are securely wealthy, with all of your financial goals met, you don't need to take any risk in your investment portfolio.

On the other hand, if you have some work to do to get to your long-term goal, as much as it may bother you to see some volatility - you may need have a need to take more risk. Or, to adjust your goals.

The process of balancing these tests to determine your asset allocation, backed up by a well-thought-out financial plan, is foundation of a good investment experience.