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What is Asset Allocation?

Asset allocation is the process of developing a diversified investment portfolio by combining different asset classes in varying proportions. Asset classes are groupings of assets with similar characteristics and properties such as U.S. large company stocks, government bonds, international stocks, and Treasury Bills. Every asset class has characteristics distinct from one another and, as a result, may perform differently in response to market changes and economic conditions. How important is it to have an appropriate asset allocation?

“... more than 90% of the variation in a portfolio’s performance over time is due to asset allocation”
Source: “Determinants of Portfolio Performance”, Brinson, Hood, & Beebower, Financial Analysis Journal, July/August 1986

“… investment policy (asset allocation) dominates investment strategy (market timing and security selection)”
Source: “Determinants of Portfolio Performance”, Brinson, Hood, & Beebower, Financial Analysis Journal, July/August 1986

“… for the long-term investor…the asset allocation decision is by far the most important”
Source: “Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?”, Ibbotson & Kaplan,  Financial Analysts Journal, January/February 2000

We work with you to determine the appropriate asset allocation for your portfolio.  Although the process of diversifying your assets across multiple asset classes can help to reduce overall risk, it does not eliminate market risk altogether.

Reducing Risk with Bonds and Cash Equivalents

Investment managers try to balance risk and return in a portfolio. Both historical data and portfolio theory confirm that the expected returns on stock investments are greater than the expected returns on bonds and cash equivalents. As a result, portfolio managers make stock investments to pursue higher returns and use diversification in the portfolio to help reduce risk.

Even a broadly diversified stock portfolio, however, may still have more volatility than is desired. To reduce risk, less volatile asset classes can be included in the portfolio – bonds and cash equivalents. These asset classes have traditionally been considered to be primarily income producing. Academic research, however, has shown that the primary reason for their inclusion should be to reduce volatility. FMS utilizes a variety of bond and cash investment strategies to design portfolios with lower risk to help meet a client’s investment needs and risk tolerance.