Portfolio structure, or asset mix, determines most of the performance in a diversified portfolio. Each of the several asset classes play a different role in a portfolio. The investor’s need for growth balanced with individual risk tolerance guides the portfolio’s asset allocation.
The video presented by principals of Dimensional, our strategy partner, review the principle of asset allocation in portfolio structure.
Capital markets are composed of many classes of securities, including stocks and bonds, both domestic and international. A group of securities with shared economic traits is commonly referred to as an asset class. There are several asset classes, all with average price movements that are distinct from one another. Investors can benefit by combining the different asset classes in a structured portfolio.
A full range of domestic, international, and emerging market asset classes includes: small, large, value, and growth stocks; government, corporate, and municipal bonds; real estate; and commodities. Because the asset classes play different roles in a portfolio, the whole is often greater than the sum of its parts. Investors have the ability to achieve greater expected returns with less price fluctuation and more consistency than they would in a less comprehensive approach.
However, because no two investors are alike, there is no single “optimal” asset allocation. Each investor has his or her own risk tolerances, goals, and life circumstances that dictate the holdings in their portfolios. The key role of your advisor is to help you determine an appropriate mix. In general, the greater the proportion of stocks a portfolio holds, especially small cap and value stocks, the more “aggressive” is its risk and the greater is its expected return.