Finance

Personal Investments: Asset Allocation

Why it pays to diversify your asset allocation

“Don’t put all your eggs in one basket” is a phrase loved equally by mothers and investment bankers.

Asset allocation is an investment strategy that consists of having an investment portfolio with different asset classes in order to balance risk and reward. With asset allocation, If the basket falls, you still have some safe eggs.

There are different classes of assets in an investment portfolio including:

  • Equity (stocks)
  • Fixed-income (bonds)
  • Cash equivalent

Why asset allocation matters

Asset allocation is a form of protection against potentially devastating loss. If the market takes a dive, having different classes of assets will minimize the effects on your overall portfolio.

The best strategy depends on your goals. Someone who is looking for a longtime steady investment will have a vastly different portfolio then someone who is hoping to use the money in less than five years.

There are several different asset types. In this article we’ll examine stocks, bonds, and crypto.

Stocks

You don’t have to be an investor in Shark Tank to support and profit from a company you admire.

Stocks are shares of ownership. Let’s say you purchase a stock in Company X. You effectively own a small part of this company. If they succeed you will make back the original money you spent buying the stock and more. If they fail, the stock you bought could be worth less than you purchased it for.

If all goes well, this is a win-win situation for both the company and the investor. Some companies may choose not to be publicly traded, as having a large variety of investors poses additional challenges, such as a lack of control and increased expenses.

Publicly traded companies sell stock through a stock market exchange. The prices of these stocks are based on the companies worth, known as their market cap. You can calculate the market cap by multiplying the share price by the number of stocks outstanding.

The share price is determined by supply and demand.

Supply and demand 101

In case you slept in your Freshman year economics class, here’s an example of supply and demand:

Let’s say five first-graders have a box of toys to play from which includes three types of toys: plastic balls, dolls, or toy cars. They trade these toys depending on which they want to play with. In this scenario everyone wants to play with the five toy cars available, while the dolls and balls aren’t as popular. In fact, the kids playing with the cars won’t give up their cars for anything less than five dolls and two balls.  Now let’s say that there are only two cars in the entire box. A kid may now ask for seven dolls and four balls. The supply went down, so the demand went up.

This creates a pretty ridiculous demand curve, but you get the point.

This concept seems basic, but it can be key in determining the prices of stocks. Unlike our hypothetical toy box, the demand can fluctuate quickly for stocks, while change in supply takes far more time.

Which stocks you invest in depends on your risk tolerance and overall goal. Stocks tend to be riskier than bonds, but safer than Cryptocurrency.

Cryptocurrency

Cryptocurrency, commonly referred to as crypto, has recently risen to popularity, generating both media buzz and attention from the financial investment industry. Cryptocurrency is a digital currency that the IRS deems a financial asset.

Unlike traditional forms of money, the value of crypto often varies. It is meant to be a secure form of payment online, but has been subjected to several criticisms for its potential for aiding illegal transactions.

There are  thousands of different types of crypto. Some of the most popular are Bitcoin, Ethereum, and Cardano.

Cryptocurrency’s market price fluctuates based on supply and demand, similar to stocks. Due to its relative scarcity, it’s value can surge dramatically. An example of this is Bitcoin who’s value reached over $17,000 in late 2017 only to drop dramatically.  Cryptocurrency is not right for every investor. It’s fairly new, highly volatile, and offers both high risk and potentially high short term reward.

Causal’s templates can provide a forecast for your investments that offers a range of possible scenarios, rather than a single outcome. Crypto is extremely volatile, which makes forecasting with (un)certainty essential.

Bonds

A bond is a loan, usually to a company or the government, that an investor lends and collects interest on. Bonds are a  fixed income instrument, meaning that the investor receives payments through the regular fixed interest and the eventual payment of the bond.This makes it a fairly steady and low risk asset.

The characteristics of a bond are:

  • The terms for it’s payment
  • It’s interest
  • The time it matures.

Bonds, like stocks, have a fluctuating market price and can be bought and sold.

A bond’s market price is dependent on:

  • The quality of the bond
  • When the bond reaches maturity.

Typically, the longer the bond takes to reach maturity, the higher the interest. An investor will receive periodic returns in the form of this interest, on what is known as a bond’s coupon date. Once a bond reaches maturity a set face value is paid.

How Casual can make asset allocation simple

Causal’s customizable templates for personal finance can help you determine the best strategy for your investment portfolio through forecasting.

For example, our Asset Allocation Backtest template calculates the value of your portfolio and compares two strategies for the maximum return. Unlike other online investment calculators, Causal’s personal investment model template can take into account a person's ability to invest more over time and calculate a range of possible outcomes.

Your investment portfolio is full of potential outcomes, Causal makes forecasting simple so you can choose the best strategy for your goals.

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