By: Eugene Botha, Deputy CIO at Momentum Investments
Staying invested often sounds easier than it really is, due to our inherent desire to control our investment outcome. The problem is often that the focus becomes too short term, risk is not clearly defined or understood and we get swayed by our emotions, making it an increasingly difficult task to stick to a strategy that is designed for the longer term.
So, how do we plan and sculpt that ‘optimal’ asset allocation for an uncertain future? The key is to have a strategic asset allocation mix, which assumes you don’t know what the future is going to hold.
Asset allocation is simply a more scientific version of the old adage “Don’t put all of your eggs in one basket”. It is a way to potentially protect against a major loss, should things turn out differently relative to expectations.
Selecting the right asset allocation depends on several factors, including:
- Time horizon: The number of months or years to achieve a financial goal is the primary factor driving asset allocation.
- Risk tolerance: Investors’ ability and willingness to lose a larger proportion of their original investment in exchange for potential greater returns is the second major factor.
Asset allocation helps investors reduce risk through diversification. Historically, the returns of equity, bonds and cash haven’t moved in unison. Market conditions that lead to one asset class outperforming during a given timeframe might cause another to underperform. This results in less volatility for investors on a fund level since these movements offset each other.
Constructing an ‘optimal’ client-focused strategic asset allocation is essential to make sure you achieve your clients’ financial goals. Investors that aren’t taking on enough risk might not generate high enough returns to achieve their goals, while investors taking on excessive risk may not have enough money when they need to access it. Selecting the right asset allocation helps avoid these issues by making sure a fund is ideally positioned to achieve a goal.
The key here is to have a clearly defined objective to deliver on and a firm understanding of what the expectations are in terms of investment horizon, risk management focus and resultant return objective. Or in simple terms – the client goal.
An asset class strategy or appropriate investment solution can then be designed, constructed and managed in a way to deliver on the overall objective. It is therefore important to understand risk in an appropriate and relevant way.
Risk tolerance is about knowing where the line is drawn between acceptable and unacceptable outcomes. Risk tolerance should ideally reflect an investor’s ability to take risk, and not the willingness to tolerate risk. If willingness is lower than ability, huge opportunity costs may be incurred. Willingness to take risk is often wrongfully driven by emotions, peer pressure and herd behaviour.
It can at times be frustrating to experience short-term volatility and the temptation will be to move more of your investments into the asset class that is doing the best. This is when it is important to remind yourself that maintaining an asset allocation strategy based on risk tolerance, time horizon and goals is an established way to have more success with investing and ultimately deliver on the intended goals.
With so many things in life out of our control, it can bring comfort to focus on things we can control. Asset allocation is one of the few things that can be controlled when it comes to investing and it just may be one of the most important. Focusing on a disciplined asset allocation strategy rather than the whims of the market is a key component of achieving your clients’ personal financial goals.
Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406)
