Invest In The Right Assets

When we visit a stall, we may come across one that sells completely unrelated products, such as umbrellas and ice cream. On the surface, selling such unrelated products may seem counterintuitive.

After all, it is unlikely that a customer would buy both items at the same time. When it is raining and cold, it is easier to sell umbrellas and harder to sell ice cream. The reverse is true during a sunny day. Nevertheless, further examination shows that by selling both unrelated items, the stall operator reduces the risk of not making money on any given day.

Such a business concept is also applicable to asset allocation to manage investment risk. The modern portfolio theory developed by Harry Markowitz and William Sharpe has shown that an ideal way to maximise returns based on a given level of market risk is to combine asset classes via asset allocation rather than focusing on individual securities.

So what is asset allocation? Asset allocation involves dividing an investment portfolio among different asset classes with varying risk profiles and potential returns. The key objective is to compensate for any losses from one asset class with gains from another, thus reducing the overall portfolio risk. It is important to note that asset allocation does not completely shield the portfolio from investment losses.

The core asset classes in a portfolio typically include, but are not limited to:

1. Equities

Equities are partial ownership of companies usually listed on stock exchanges. This is effectively investing in a company's growth prospects. Suppose the company is successful and performs well financially. In that case, the investment can provide a positive return in capital gains when the share price rises and/or if dividends are paid, and vice versa. Equities are high-risk and high-return investment instruments.

2. Fixed Income instruments such as bonds and sukuk

Fixed income instruments consist of bonds/sukuk and loans/financing. An investor lends money to/finances another party in return for interest/profit and potential capital gains. Historically, bonds/sukuk are less volatile than equities. The trade-off is potentially a more modest return. Nonetheless, some types of bonds/sukuk are riskier, such as junk bonds and high-yield bonds.

3. Cash & Cash Equivalents

Fixed income instruments consist of bonds/sukuk and loans/financing. An investor lends money to/finances another party in return for interest/profit and potential capital gains. Historically, bonds/sukuk are less volatile than equities. The trade-off is potentially a more modest return. Nonetheless, some types of bonds/sukuk are riskier, such as junk bonds and high-yield bonds.

The asset allocation that works best for an investor at any given point in life will largely dependent on two key factors:

• Investment horizon
  The number of months or years an investor will be investing to achieve a particular financial goal is the primary consideration in determining asset allocation. An investor with a longer-time horizon may be more comfortable investing in riskier assets because he/she could withstand economic cycles and market volatility. Meanwhile, an investor who is investing to achieve a short-term investment objective may prefer less risky investments since he/she has a shorter-time horizon.
• Risk tolerance
  Risk tolerance is an investor's ability and willingness to risk some of his/her capital in exchange for higher potential returns. An aggressive investor with high-risk tolerance is more likely to take on higher-risk investments to achieve better returns. A conservative investor with a low-risk tolerance may prefer lower-risk assets that potentially provide more modest returns.

The Importance of Asset Allocation

On top of diversification to minimise overall portfolio risks, asset allocation is important to ensure that an investor achieves his/her financial goals. For instance, an investor with a conservative portfolio may not generate sufficient returns to reach his/her financial goal. Therefore, having suitable asset allocation will ensure that a portfolio is ideally positioned to attain a financial goal. According to Vanguard Research, asset allocation accounts for 88% of an overall portfolio's return and volatility. This means that an investor should emphasise more on asset allocation rather than stock picking when it comes to reaching his/her financial goals.

In short, asset allocation is one of the most important investment decisions in achieving one's financial dream. By selecting the right mix of equities, bonds/sukuk, cash, and other asset classes, you can ensure that you are on track to reach your financial goals.

In Alliance Bank, we adopt a systematic and comprehensive approach where we will conduct an investor suitability assessment with you to understand your (1) investment objectives and life goals, (2) expected return from investing, (3) planned investment horizon, and (4) risk tolerance.

We will then construct an investment portfolio with you based on the criteria mentioned above to ensure that the asset allocation fits your investment objectives and your risk profile. Furthermore, we will carry out periodic portfolio reviews with you to ensure that the asset allocation continues to match your investment objectives and risks.

We strive to be the most important relationship for the financial success of our customers. This is also aligned with our bank's mission, ‘Building Alliances to Improve Lives.’

So by investing with us, you know you are in good hands.