How to Define your Asset Allocation

Do you know what your asset allocation is? Or what it should be? Do you even know what I’m talking about?
 
Deciding on your asset allocation is an important part of investing. I would even say that it should be one of the first steps in your investing journey. After all, you kinda need to know where you’re going before you leave your house, and it’s a great idea to have a map too.
 
Your asset allocation will guide your current and future investments. Even if you are a new investor, I’m sure you’ve heard the saying “buy low and sell high” right? Your asset allocation is going to help you decide when things are “low” or “high”, and which asset classes to buy more of.
Your asset allocation is like a map that you create. It shows you which percentage of your assets should be allocated to what asset class. This can be done in any format that you like, a chart, list, table or a spreadsheet (my preferred method).
 
Defining your asset allocation is not complicated. To get started you will first need to analyse your investor profile and risk tolerance. Here are some questions to help you determine the ideal asset allocation for you:

In investing these questions are repeated again and again, but those are very important questions. And to be honest, if you’re just starting out and have not had the experience of seeing the stock market plummet (hello March 2020) you’re not truly going to know how you’re going to react. And that’s okay. But you can probably have a good idea just upon reflecting on your personality.

Oh, and notice how I said “when the value of your portfolio drops” and not “if the value of your portfolio drops”? If you’re investing for the long term – which is what I do and would recommend – then it’s not a matter of “if”, but a matter of “when”, and you have to be prepared. Taking this into account only allocate a percentage that you are comfortable losing to more risky asset classes.

Again, you must reflect on your personality and lifestyle. You see, personally, I really enjoy “doing my finances” each week, looking at my asset allocation and deciding where to put my money next. Other people are just not interested in spending their precious time looking at spreadsheets. If that sounds like you, you should probably consider having the majority of your assets in index funds that are easy to manage, rather than individual stocks, for example.

This is really a question that only you can answer, and while some specialists recommend diversifying your portfolio (and others recommend having 100% of your assets in  Total World ETF) there is no right or wrong answer.

Think about what country you live in, what the economy is like in your country and others, the economy in different parts of the world, the types of assets that are personally interesting to you. When diversifying, don’t forget to take into account how much you would feel comfortable having in fixed or variable income securities.

See, I live in New Zealand. We have a stable economy and market with very low interest rates and inflation. Even though the economy is solid, NZ is a very small country and therefore has a small economy. For this reason I wouldn’t want to have all my assets invested in the local market, and I choose to allocate a large portion of my net worth to investments in other countries (like United States and Australia). I also like to have a small percentage of my assets in peer to peer lending, which although can be a little bit risky, it is not directly influenced by the stock market fluctuations. I’m comfortable with that.

After you’ve given these questions some thought, you can start drafting your asset allocation. What is it going to look like? See tables below for some examples:

Asset allocation example - S&P500 50%, Small Cap Index 20%, Property 20%, Individual Stocks 10%

Perhaps the 10% in individual stocks will be allocated like this:

Individual stocks asset allocation - tesla 3%, apple 3%, microsoft 2$, amazon 2%

Or maybe your allocation will look like this:

asset allocation example - total world etf 60%, individual stocks 20%, bonds 10%, peer to peer landing 10%

You can of course make your fancy using pie charts, graphs and things like that. I choose to keep mine simple and I use a spreadsheet.

These examples do not show cash, but I would definitely recommend having an emergency fund in cash as well (which should really be the first step in your financial independence journey).

Yes! Yes! Definitely! Start with what you have, even if it’s not much. It might take a few weeks to build up the minimum investment for some funds (and you might only need a small amount for others), but that doesn’t matter. What matters is that you give each dollar a purpose, even if it sits in a separate account until you have enough to make your first investment. If you do that, though, make sure you keep track of where each dollar is going to be invested in, and once that leaves your main account that is it. Pretend you can’t see it anymore, it’s not money to be spent.

Now decide where you’re going to start. Is it going to be index funds? Do some research and find out how to invest in index funds in your local area. You can do this through Vanguard if you’re in the United States for example, or through Smartshares or Superlife if you’re in New Zealand.

Are you going to start with individual stocks? Sign up for a share trading account and start there. This post is simply about asset allocation, but make sure to research how much you will be paying in fees before you decide on which company you to use.

I hope this post helps you understand a little bit more about asset allocation, a very important concept if you’re just starting out. Let me know your thoughts in the comments 🙂

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