Asset Allocation

Question 1

Define asset allocation and it’s importance

Answer 1

1. Asset allocation refers to the mix of asset classes in a portfolio (e.g., cash, fixed-income securities, alternative investments, equities).
2. Different asset classes have unique risk and return characteristics.
3. Studies show asset allocation is the most important factor in determining portfolio returns. It allows for diversification benefits.
4. Security selection, fund selection, and market timing are less influential on long-term returns.

Question 2

What are the benefits of diversification within a portfolio?

Answer 2

1. Different asset classes are not perfectly correlated, so spreading investments reduces risk without necessarily lowering returns.
2. The client’s risk profile influences their asset allocation:
   A. Higher risk tolerance → More equities.
   B. Lower risk tolerance → More bonds or cash.

Question 3

Explain the concept of “The 60:40 Balanced Portfolio”

Answer 3

1. A common recommendation for retail investors.
2. 60% equities for growth, 40% bonds for stability.
3. Allocation shifts with age (e.g., 80% equities for younger investors, 50% equities near retirement).

Question 4

How should investment recommendations be made in relation to a client’s asset allocation and risk profile?

Answer 4

1. Specific investment choices should align with the agreed asset allocation based on the client’s goals and risk profile.
2. Advisers should tailor portfolios to individual needs, ensuring alignment with the overall strategy.