Asset Allocation Strategies for Conservative and Aggressive Investors

Asset allocation refers to an investment strategy that helps companies and individuals to allocate their investments in cash, bonds, stocks, and other securities. Assets classes differ when it comes to yields and level of risk. The main classes are cash and equivalents, fixed-income securities, and equities.

A fixed-income security is an investment instrument that offers fixed payments, the amount of which is known in advance. Equities are held as different collective investment schemes with the aim of asset diversification. Cash and equivalents are investment securities and liquid assets with a good credit quality. Apart from the main asset classes, allocation strategies also include other instruments such as venture capital, currencies, derivatives, insurance, and residential and commercial real estate. There are different types of insurance products such as life insurance, catastrophe bonds, and life settlements. A catastrophe bond, for example, is a high-yield type of debt instrument. It is an insurance product designed to collect money for earthquakes, hurricanes, and other catastrophic events. Also called life insurance it allows people to sell their insurance plan to a third party to raise cash.

Different Strategies

Asset allocation strategies also include instruments such as distressed securities, merger arbitrage, stocks, and commodities. There are different types of commodities, including energy and broad basket. Collectibles and items of value include stamps, gold coins, artworks, and others. There are different fixed-income securities such as convertible stock, corporate and government bonds, and junk bonds. Junk bonds are high-yield securities that carry a high default risk. Investors usually use them for speculative purposes. The interest rate is typically 3 – 4 percentage points higher than that of government bonds. Bonds that carry a higher risk of default are called non-investment grade or speculative. Distressed securities are offered by governments and businesses that are in distress, going through bankruptcy, or in default. This usually happens when a business or entity is unable to make payments and meet its financial obligations. Distressed securities can be in the form of corporate bonds, trade claims, debt, and preferred and common stock.

Conservative and Aggressive Investors

Asset allocation strategies are based on different factors, including portfolio diversification, timeframe, risk tolerance, and investment goals. There are five investment risk categories, including aggressive, conservative, and moderately conservative. Aggressive investors usually hold sector and growth exchange traded funds, as well as mutual funds and stocks. A moderate portfolio, on the other hand, includes a balanced mix of different asset classes. Such investors aim to strike a balance between loss reduction and profits. Conservative investors avoid risky assets and hold their money in intermediate and short maturity bonds and cash. They invest defensively to eliminate risk and lose the most in times of rising or high inflation. Conservative investors are the ones to invest in bank instruments such as CDs, fixed-income securities, and money market funds. Cash, including certificates of deposit, money market funds, and savings accounts, loses value because of the effects of inflation and taxes.

Based on risk tolerance and other factors, there are 3 types of asset allocation strategies – core satellite, tactical, and strategic. Tactical asset allocation is for investors who prefer a proactive approach and high-yield investment instruments. This strategy is moderately active, aiming to make the most of strong market sectors, high-potential stocks and assets, and pricing abnormality. With this strategy, investors start with an allocation like 10 percent cash, 30 percent bonds, and 60 percent stocks. Investors underwrite stocks in case their valuations are high or buy stocks if they are undervalued. Thus, the portfolio will contain 40 or 70 percent stocks, respectively.

Strategic asset allocation aims to balance return and risk in the long run. It is a long-term strategy that is adjusted in case a major event occurs, i.e. retirement, serious illness, promotion, job change, etc. Core-satellite asset allocation combines elements of the tactical and strategic allocations.

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