What Is Asset Allocation?

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When it comes to the money in your company's account, it often feels as if there is never enough. For the set amount of funds an individual or a business has at its disposal, there might be a hundred worthy uses. All of these must be carefully considered so the best possible decision is made and the available money yields the most positive results. In essence, this is what asset allocation is all about. Asset allocation in investing is usually broken down into stocks, bonds, real estate holdings and cash.

Tolerance for Risk and Time Horizon

Depending both on your tolerance for risk and the time horizon you have available, you may choose to distribute your funds differently. Similarly, business owners must work closely with financial advisors, department heads, company leadership and accountants to determine the best way to use the limited funds they have at their disposal to grow the business to the fullest extent. Whether it be through market investments or pouring funds back into company projects, careful consideration of your available time and tolerance for risk are key to properly allocating your assets.

Asset Allocation Strategies

A critical aspect of asset allocation is aiming to reduce risk. In the case of investors who are putting away funds for retirement, the reduction of risk will help them maintain control of as much money as possible for their future. This can be achieved by putting only some funds into high-risk stocks and reserving others for bonds or low-risk mutual funds. Similarly, keeping some money in a high-yield savings account can be a good strategy for maintaining an emergency fund in case the stock market doesn’t behave as anticipated. Many financial advisors suggest keeping as little of your available funds in cash as possible since its yield will nearly always pale in comparison over the long run when compared to market options. By readjusting your asset allocation the closer you get to retirement so that more of your money is in stable, low-risk funds, you are increasing the chances you’ll be left with the majority of what you’ve set aside. When time is no longer on your side, and you need to cash in your investments, it’s best to keep your money in a less-volatile fund.

Business owners also aim to reduce risk through asset allocation. Since there are only so many profits rolling in, it’s essential that company leaders make smart decisions as to where that money should go. Is it better to reinvest the money into the business or take it as profit? Choosing to reinvest, pay down debts or otherwise keep the funds in the company’s coffers can be a good way to lower the risk your business may face in the long-term. Choosing to take some of the money as profit not only raises your tax burden, it leaves you less prepared for unexpected crises or financial expenditures that may arise down the line. Ultimately, however, the decision is extremely individual and must be carefully considered.

Much like personal investing, the greater the risks you take in business, the greater the potential rewards you may enjoy. As such, choosing to buy a new building, invest in an additional product line or put money toward new marketing efforts are all examples of decisions for business asset allocations. If these choices prove fruitful, it could mean more money for your company. Whether or not you are willing to take these risks is ultimately a decision that leadership must make together. If it seems that the potential reward could outweigh the risk of losing your investment, the decision is likely a sound one.

Diversifying your business assets is an excellent way to lower your risk and increase the chances that you will enjoy a positive return on your investments later on. It’s wise to put some of your company’s assets into lower-risk projects, like purchasing a new sign for your storefront to encourage foot traffic, as well as into higher-risk ones, like buying a new building so that you can open a second location. The chances of success are greater this way, and you will be far less likely to lose all that you have invested, should something go wrong.

Dynamic Asset Allocation

You may wonder, what is dynamic asset allocation? This investment strategy is a useful way to keep your portfolio in check over time. This technique involves investing in certain asset classes and making frequent sales or trades as the values of the respective classes grow. They may not increase in proportion to one another. For instance, in a year when the stock market performs well, assets invested in stocks could grow more than 15 percent. Bonds, however, are likely to grow only by a few percentage points. Rather than continually reinvesting all of the extra stock money in stocks, dynamic asset allocation calls for redistributing all of the assets across all categories to keep them in the same proportions.

Say, for instance, that you wish to invest $50,000. Due to your time horizon and your risk tolerance, you elect to put $35,000 (70 percent) of the money into stocks. You choose to put $10,000 (20 percent) in bonds and the remaining $5,000 (10 percent) in cash. The market has a great year, and you earn $5,000 from it. Your bonds yield only $300, however, and your cash just $50. For the year, you have a total increase of $5,350, yielding total assets of $55,350. If you wished to adhere to dynamic asset allocation, you would redistribute your funds so that $38,745 was invested in stocks, $11,070 was in bonds and $5,535 in cash. This way, the percentage of your assets that were held in each category would remain consistent.

Business can apply dynamic asset allocation to their investments, as well. For instance, you might choose to take only 10 percent of available assets as profits, no matter how much money might be available. This is an excellent strategy to ensure that you are continually investing in your company and helping it grow.

Companies can also invest in stocks, bonds, real estate or high-yield savings accounts in the same ways that individuals do. This is an excellent way to grow the organization’s available assets. The same asset allocation best practices should be followed to ensure that you don’t take too much risk and that your time horizon is considered. If your company’s five-year-plan, for instance, outlines the purchase of a second building, investments in the market, bonds or real estate should not tie up the assets you would need for the building. Though it might seem as if you could pull your money out of your investments at any time, losses in a down year could set you back significantly. The funds you need for important company projects in the short term should always be set aside in a low-risk way so that they are available when you need them.

Tactical Versus Strategic Asset Allocation

Much like basic dynamic asset allocation, strategic asset allocation requires investors to set ideal proportions for each class of investments and periodically rebalance their portfolio. This is less like active trading and more of what is known as a “buy and hold” approach, since individuals or businesses are committed in the long term to their investments and buy or trade only to maintain the balance of their funds. With changing goals or the reduction of time before an end goal, such as retirement, the proportions set for each asset class may need to change. As a company, you might decide, for instance, that you would invest 50 percent of your funds in stocks, 30 percent in bonds, 10 percent in real estate and 10 percent in cash.

Tactical asset allocation, on the other hand, makes a slight change to the concept of dynamic asset allocation. This approach allows for ranges of appropriate proportions, rather than one set number for each asset class. The benefit to this sort of strategy is that it allows for reactions to the market, which could benefit the investor. If stocks are doing well, a company could move the maximum assets it has allocated for that fund type into the market. This would leave another category, like bonds, at the lower end of its acceptable range. When stock values begin to drop again, the investor could sell some of their stocks so that they were back at the lower end of their acceptable range for that fund type and invest the difference back in bonds. For example, your stock range might be 40-to-50 percent stocks, 20-to-30 percent in bonds, 10-to-20 percent in real estate and 10-to-20 percent in cash.

Insured Asset Allocation

There is another asset allocation strategy that appeals to risk-averse investors. Called insured asset allocation, this technique involves setting a threshold below which you will not permit your portfolio to drop. As long as your assets stay at or above this threshold, you actively manage your funds, including buying and trading stocks in accordance with market trends. The idea behind this strategy is to help the portfolio grow as much as possible while still limiting your risk at a predetermined level. In an insured asset allocation scenario, should your portfolio ever drop below the limit you have set, you can choose to invest in Treasury bonds or other extremely low-risk fund classes to maintain the assets you do have. Then, you could reassess your investment strategy or wait for the market to regain its strength before making any further changes to your portfolio.

Asset Allocation for Business Owners

Something that’s important to consider if you are the owner of a small business is how your personal asset allocation strategy takes into consideration your company. Though you may develop a financial plan and wealth management strategy independent of your business, your business may be one of your biggest assets. The potential profit you could realize from the sale of your company in the future could be worth more than your entire investment portfolio, so it’s an important thing to consider.

However, it’s important to not overemphasize the importance of your business in your overall financial portfolio. Investments outside of your company are critical for the stability of your assets and things like your retirement plan. You should view your personal assets and company assets as two separate but interrelated entities. It’s OK to invest some of your money back into your business, but not at the expense of your personal investments. Likewise, you should never pull all of the profits from your company to give yourself a bigger bonus. Instead, it’s usually far more prudent to reinvest some of that money into your business and help it to grow. This delicate balance of personal and business assets is, in a sense, its own kind of asset allocation. Carefully watching and maintaining the balance between your personal investments and your business assets is a critical part of being an entrepreneur.

References

About the Author

Danielle Smyth is a writer and content marketer from upstate New York. She has been writing on business-related topics for nearly 10 years. She owns her own content marketing agency, Wordsmyth Creative Content Marketing (www.wordsmythcontent.com) and she works with a number of small businesses to develop B2B content for their websites, social media accounts, and marketing materials. In addition to this content, she has written business-related articles for sites like Sweet Frivolity, Alliance Worldwide Investigative Group, Bloom Co and Spent.