What Is Asset Allocation and Why Should You Know It?

The Asset Allocation is one of the most important processes to succeed in an investment, how is it integrated into the construction of portfolios? Why is asset allocation important for an investment? We answer these questions below.

WHAT IS THE ASSET ALLOCATION?

Asset Allocation is translated in Spanish as “asset allocation”. This is the process of selection, inclusion, and distribution of financial assets in an investment portfolio, according to a defined strategy.

It is important not to confuse the concept of Asset Allocation with Stock Picking (stock selection). Both tasks are key in an investment. However, the allocation of assets is broader than a simple selection of securities: it defines the precise combination of them to provide the portfolio with a correct diversification and adapt the risk of the same to the profile of the inverter. You must always keep in mind the objectives and investment policy.

On the other hand, the selection of securities (Stock Picking) consists of identifying which securities, taken individually, of a certain class can be included in the portfolio (for example, which shares of Spanish companies with large market capitalization will be appropriate).

Therefore, we can define the concept of Asset Allocation as a process to distribute wealth in a manner appropriate to the interests, preferences, and objectives of each investor profile. Not a simple selection of financial assets.

THE INVESTMENT PORTFOLIO DESIGN PROCESS

You may have heard of some action or financial instrument that is offering very good results, but investments based on rumors do not usually end well, as well as the assurance that this investment is suitable for our objectives, interests, or level of risk allowed.

An investment requires time and financial knowledge to analyze the assets, with greater reason when it comes to building an investment portfolio.

But why is it necessary to build a portfolio? Wouldn’t it be better to allocate our capital to one or a few financial assets that we know? The answer is given by the concept of diversification.

The diversification has the effect of reducing the risk. By performing it correctly, we can shape the volatility of our global investment. Without a well-diversified portfolio, we are exposed to the vagaries of individual financial assets, the swings of a given market, and the existing economic conditions.

To design an investment portfolio, we must first keep in mind issues such as:

  • What is our risk tolerance?
  • What goals do we intend to achieve?
  • What time will horizon our investment cover?

With the answer to these questions, we will be able to design an investment policy that takes into account the relevant restrictions and tries to optimize the profitability – risk binomial.

Correct allocation of assets is one of the tasks that make it possible to create a portfolio adapted to our preferences, objectives, and level of risk: Asset Allocation comes into play throughout this process.

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