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Balancing Risk and Reward: Mastering Asset Allocation In A Shifting Market

By: Scott Van Den Berg, CFP®, ChFC®, CEPA®, AIF®, CRPS®, CMFC®, AWMA®

In the ever-evolving world of investments, the ability to balance risk and reward through strategic asset allocation is crucial. For more than 30 years, I have seen firsthand how market fluctuations and global economic events can impact investment portfolios. Whether you are a novice or seasoned investor, it is important to understand how to effectively structure your investments to optimize returns while managing risk, especially in a shifting market.

Understanding Asset Allocation

Asset allocation involves diversifying your investments across various asset classes - such as stocks, bonds, real estate, commodities, and cash - to balance risk and reward according to your investment goals, risk tolerance, and investment horizon. 

Importantly, reviewing your asset allocation should not be done in a silo. It is prudent to incorporate this review at both your individual account level, as well as at your household level.  For example, at the account level you might think about how your 401(k) is diversified between stocks, bonds, and cash. However, when reviewing the asset allocation at your household level, you would not only consider your 401(k), but all your other investments and savings accounts. 

This household view allows your diversification and investment decisions to be made on a more comprehensive, holistic level versus making investment decisions in just one of your accounts, without taking into consideration all your financial moving parts. Moreover, household level asset allocation can also help drive tax efficiency.

Adjusting to Market Shifts

Market conditions are constantly changing, influenced by factors like economic cycles, inflation, interest rates, geopolitical events, government regulations, technological advancements, and at present…excessive government debt levels. These changes can affect different asset classes in various ways. 

For example, anyone who was invested in the market in 2008 (i.e., “during the Great Recession”), saw the values of their investments change drastically from this economic event, as it affected asset classes in different ways. Riskier securities (e.g., those that were more leveraged) were sold off in large quantities, while more conservative investments, such as U.S. Treasury bonds, became more valuable. 

Having a thoughtful, risk-adjusted investment allocation that helps to accomplish your short, mid, and long terms financial goals is important to achieving financial success. It is material that you remain diligent and flexible enough to adjust your allocation from time to time, as personal and economic circumstances change. Remember, the only constant is change!

The Role of Diversification

Diversification is a key component of asset allocation. By spreading investments across different asset classes, geographical regions, and market sectors, you put yourself in the position of decreasing the likelihood of sustaining significant losses. This is the key!   

Diversification aims to maximize returns, on a risk adjusted basis, by investing in different areas that are not highly correlated, thus helping to protect against any one investment or macro event that is out of your control, potentially causing you a financial disaster. Bottom line, by avoiding big losses, over time, diversified investments help create true wealth. 

Risk Tolerance and Time Horizon

Each investor’s risk tolerance and time horizon play a critical role in determining their optimal asset allocation. Younger investors might lean towards a more aggressive allocation, favoring stocks for long-term growth, while older investors might prefer a higher allocation to bonds for income generation and stability as they enter and enjoy retirement.

Other Important Considerations

Considerations such as income needs, liquidity needs, tax brackets, longevity, and charitable aspirations also play a role in how one should think about diversification. For example, do your investments provide protection and potential profit during periods of higher inflation? Do you have enough cash and income to allow you to weather a financial storm that could last a few years without being forced to sell investments when they are temporarily down to meet your income or cash needs?  Do you have enough diversification so that the investment volatility you will endure does not keep you up at night? Does your diversification allow you to invest and generate income in the most tax-efficient manner?

Continuous Portfolio Review

Regular portfolio reviews at the individual account and household level are necessary at least a few times per year to help ensure your asset allocation continually stays aligned with your goals, especially as financial markets and your personal circumstances evolve. Adjusting your investment allocation should not be done on the fly. Adjustments to individual investments and asset classes require careful thought and consideration. 

Understanding your individual risk tolerance, financial goals, liquidity needs, time horizon, broader market valuations, individual investment valuations, and tax consequences are just a few of the considerations that can have big impacts on how, when, and where you should diversify.  

At Century Management Financial Advisors, we are committed to helping our clients navigate these complex decisions, providing guidance tailored to each investor's unique situation.

Asset allocation is not a one-time decision but a dynamic process that plays a crucial role in your investment and financial journey. As we navigate through these challenging times, the ability to adapt and reevaluate will be key to achieving long-term financial success.

Century Management ("CM") is an investment adviser registered with the US Securities and Exchange Commission. Registration does not imply a certain level of skill or training. CM is also registered as a Portfolio Manager in the Province of Ontario. More information about CM’s investment advisory services can be found in its Form ADV Part 2A and/or Form CRS, which is available upon request and also at www.centman.com. Past performance is not indicative of future results. This discussion is not intended to be investment advice and does not consider specific client objectives. CM is not making a recommendation for or endorsing any investment strategy or particular security.  All investments involve risk and unless otherwise stated, are not guaranteed. Principal loss is possible. Forward-looking statements are not guaranteed. CM does not provide legal or tax advice and the information herein should not be considered legal or tax advice.  CM-2024-01-31