Asset allocation is a basic principle of any investment strategy and is critical in terms of financial planning. As a strategy, it aims to balance risk and reward by adjusting the percentage of each asset in an investment portfolio according to your risk tolerance, investment goals and time frame.
As you move closer to retirement a higher focus should be placed on capital preservation in order to fund your post-retirement years, along with a soothing out of portfolio volatility. Asset allocation is key to achieving both of these as the strategy will naturally point towards the lower risk asset classes of bonds and cash.
In the past this was a relatively straight-forward exercise, as the traditional “safe-haven” assets of bonds and cash were providing broadly satisfactory returns, in excess of inflation, that satisfied the requirements of retirees as well as life and pension funds.
Following the financial crisis of 2008/2009, central banks now implement extraordinary monetary policy measures on a scale never witnessed before. Interest rates have been slashed to near-zero in most developed economies, while in the Eurozone they remain in negative territory. The zero interest rate policy has been reflected in bond yields, which like deposit rates have fallen to unprecedented levels.
This has resulted in an exceptionally challenging situation for individual investors, but in particular for life and pension companies which are struggling to meet the return expectations of long-term pension investors. Investors are being essentially “forced”, through no fault of their own, to remain in higher risk assets such as equities, in order to achieve their desired return.
This is where the asset allocation process is critical for investors as it will help determine the appropriate and optimum level of exposure to the varied asset classes, from equities and bonds to property etc. It will also help determine the risk exposure of the portfolio, which should be appropriate for your investor profile.
Your risk exposure should gradually reduce as you move toward retirement and the ‘Rule of 100’, is a good indicator of the level of exposure you should have. The rule works on the simple basis of subtracting your age from I00, with the difference being the “guided” level of exposure. For example a 65-year-old investor should have a maximum indicative exposure of 35% while a 30-year-old investor, with a longer investment horizon and therefore a higher level of risk tolerance, could have up to 70% exposure to risk assets.
While this 100 Rule is a useful guide, that is all it is – a general guide. To be absolutely comfortable with your portfolio allocation and risk exposure within their portfolio we would recommend the following:
- Maintaining a diversified portfolio
- Ensuring your portfolio is appropriate for your age and financial circumstances
- De-risking your portfolio as your near retirement
- Regularly reviewing your portfolio to ensure appropriate asset allocation
To speak with a Portfolio Manager or Account Executive, phone the Cantor Fitzgerald dealing desk on 01 633 3633.
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