The most impactful decision for investors when building their asset allocation with their Financial Advisor is how much to invest in stocks versus how much to invest in bonds. Taking the process a step further, one can decide how much to invest in U.S. stocks versus how much to invest in international stocks, or whether they would like to overweight or underweight certain sectors of the stock market, such as health care or energy.

Another consideration is whether it makes sense to incorporate additional asset classes like real estate, commodities, or alternative investments. Every asset allocation is unique and depends entirely on each investor’s goals, needs, and preferences. No matter what this optimal mix may look like for you, it is essential to have a well-defined target asset allocation as part of your financial plan.

The Importance of Diversification

One of the core tenets of any asset allocation is diversification. In short, diversification is a way of spreading out your investments and making sure that you are not overexposed to any one asset class or area of the market. Most asset classes do not move in lock-step with one another, so by investing in a diversified mix, investors are able to build a more resilient, all-weather portfolio.

Diversification also helps build in a layer of portfolio insurance in instances where specific securities do not perform in the way anticipated, which frequently happens to even the most skilled investors. For example, an investor might have done extensive research and concluded that technology stocks were the most attractive investment for them with the highest potential returns. The investor’s thinking may have been sound, but what if they overlooked something in their analysis or an unforeseen event out of their control comes along that completely changes the outlook for the technology sector? Diversification helps you mitigate these risks and build a portfolio capable of performing adequately in a variety of different scenarios.

Stay Disciplined

Working with your Financial Advisor to tailor a well-defined asset allocation is only part of the battle. Reviewing and maintaining your portfolio is equally important to the initial construction and is critical to achieving long-term success.

One of the most understated but crucial parts of this is investors’ willingness to diligently stick to their financial plan and asset allocation, while remaining committed to it throughout the market cycle. This means staying disciplined during both good and bad periods, which can often be most difficult.

For example, following a prolonged downturn in the equity market, shifting more money to safe-haven bonds in response to the market turbulence may help you sleep easier at night, but by doing so, you may risk missing out on the subsequent rebound when the market does turn, which can set you back years and reduce the likelihood of achieving your goals.

Alternately, following a sustained equity bull market, investors may be inclined to shift more of their assets to stocks in order to partake in more of the market’s upside. By doing so, they leave themselves more exposed to the downside when the market does turn, which again, can meaningfully set them back in achieving their goals.

Revisit Periodically

The other part of this ongoing maintenance involves periodically revisiting your asset allocation with your Financial Advisor to reassess whether it is still appropriate for you. Have your investment goals, needs, and preferences recently changed to the extent that your asset allocation should be adjusted? Or have any new developments changed the outlooks for the asset classes you’re currently invested in?

Another important part of this stage in the process is rebalancing your portfolio, which means bringing your asset allocation back to the target weightings. Market movements can cause your asset allocation to drift over time, and what was once a 60% stock/40% bond portfolio, for example, can turn into an 80% stock/20% bond portfolio following a strong run for stocks. This is why periodically rebalancing your portfolio is essential to making sure that it is still aligned with your long-term goals.