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:

• Asset classes behave differently over time. The prices of different asset classes don’t move up or down in unison because they tend to react differently to market and economic events, consequently outperforming and underperforming at different times.
• Asset class performance is unpredictable. If different asset classes outperform and underperform at different times, you may be tempted to move your money into the best performing asset class each year. But keep in mind - the leading asset class one year can become the worst performer the next year. If you only focus on one asset class, you have to be comfortable with both of these outcomes.

Performance by design

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.

The benefits of asset allocation – Focusing on risk and return

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:

• Reduces risk and volatility. Asset allocation can’t eliminate risk, but it can help reduce it. Asset classes considered risky by themselves – such as small-cap and emerging market stocks – can actually reduce portfolio volatility if they are part of a broadly allocated portfolio.

• 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.

• Competitive returns, lower volatility. Over the long-term, an all-stock portfolio likely will outperform a blended portfolio, but it also will have much higher risk. But proper asset allocation can reduce risk as well as provide return benefits.

• 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.

What really matters – Aligning your asset allocation with your goals

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.