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While many investors focus on the specific investments in their portfolio, the most important measure of how a portfolio’s performance may vary over time is its asset allocation.1 When building your portfolio or evaluating your performance, it may be tempting to focus on the top performing asset class. But consider the following:
A well-diversified portfolio of asset classes won’t outperform the top asset class of any one year. But it won’t underperform the lowest – and that is by design. The goal of asset allocation is to focus on achieving solid long-term performance and to balance return potential with the risk you are taking.
Because asset classes perform differently over time, and this performance is unpredictable, asset allocation can provide the following benefits compared to investing in just a few asset classes:
How is this possible? If different asset classes are outperforming or underperforming at different times, it is likely that while one part of your portfolio is down, another is up, helping reduce the volatility of your portfolio.
For example, you’d expect an all-stock portfolio to have much higher returns than a portfolio with an allocation to stocks and bonds. However, stocks and bonds tend to behave differently over time, with bonds often rising when stocks drop. Therefore, a stock and bond portfolio could achieve competitive returns in relation to an all-stock portfolio over the long term, but with much less volatility. And even though asset allocation can’t eliminate declines, it can help reduce the magnitude of these declines.
Ultimately, by owning the right mix of a variety of different asset classes, your portfolio is likely to experience less volatility and show more consistent performance over time compared to a more narrowly focused portfolio.
The best asset allocation is one that is designed to help you reach your financial goals. Your portfolio’s asset allocation should provide the returns necessary to reach your goals (not outperform the market), while also aligning with your comfort with risk.
We’ve developed several portfolio objectives that reflect different asset allocations. Each is designed with the optimal mix of asset classes for a given level of risk. As you discuss your goals and risk tolerance with your Edward Jones financial advisor, you can work together to decide what is appropriate for your needs.
1Source: “Determinants of Portfolio Performance II: An Update,” Gary P. Brinson, Brian D. Singer and Gilbert L. Beebower, Financial Analysts Journal, 1991.
Past performance does not guarantee future results. An index is unmanaged and is not meant to depict an actual investment. Performance does not include payment of any expenses, fees or sales charges, which would lower the performance results. Returns include dividend reinvestment. The prices of small-cap stocks are generally more volatile than those of large-company stocks. There are special risks inherent in international investing, including currency fluctuations and political, social and economic risks. Annual returns for indexes (2007-2016) ranked in order of performance (best to worst).
Diversification and asset allocation do not guarantee a profit or protect against loss. Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.
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