Importance of Asset Mix in Financial Planning

Importance of Asset Mix in Financial Planning

The most important starting point when building a portfolio is asset mix. In fact, it is so important that if it is done incorrectly, the investor stands to not only lose over the course of his or her investment career, but will be subjected to tremendous and unnecessary strain and stress. The right asset mix will help reduce losses to acceptable psychological and, hopefully financial, limits by incorporating the following:

1. Time Availability. By incorporating an investor’s time availability, the asset mix can provide investors with an acceptable level of risk. Most evidently, short-term availability will limit the investor’s investment choice to more conservative investments so that there is little, if any, risk of loss on the principal amount being invested.

2. Investment Goals. By incorporating an investor’s investment goals into the asset mix, financial planners and even individual investors are able to see where they intend to invest. An investor is more growth-oriented will understand that their portfolio will fluctuate, sometimes greatly and will therefore be better prepared mentally to accommodate such fluctuations compared to a more income-oriented investor who would not. Knowing what your goals are is important, so make sure you give the question the attention it deserves.

3. Risk Tolerance. While time and investment goals are very important, someone with sufficient time to invest and a growth mentality will need to have the risk tolerance to support the growth investments. If risk tolerance is low in spite of the investor’s investment goals, then growth assets are normally not recommended on any large scale. Instead, growth would be limited to the point where even the most dramatic fluctuations to that part of the investor’s portfolio would have little or no consequence to the overall financial objective.

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An appropriate asset mix will incorporate each of the above factors. Conveniently, these are also the most basic questions one must ask himself or herself when constructing an investment plan; by asking these questions and knowing the answers, an appropriate asset mix can be constructed and the plan can be implemented.

In the event of shortfalls or major discrepancies (such as an investor who wants to save $1,000,000 over a 15 year period but has so little risk tolerance than a maximum annual return of 5% is more realistic than the higher rates earned on growth investments), then changes need to be made to the asset mix. That means the investors will need to re-examine how the three factors above were measured; can they take a little longer to save, can their goals shift to more aggressive, growth-oriented goals and/or can they accept a higher degree of risk. If the answer is no, then they will need to adjust their overall goal.