A chef knows the importance of mixing appropriate ingredients. While hot cheesy artichoke dip may be delicious and a fresh bowl of sliced fruit is refreshing, putting them together equals disaster. Just because two things are good doesn’t mean they are good together. Asset allocation can be equally as delicate and requires a good advisor to prepare a winning entrée.
Let’s assume that after an in-depth study of economic conditions, it is decided that technology may outperform everything else. So, we take a heavy position in a big tech stock. Our potential reward just skyrocketed. Unfortunately, so did our potential loss. Generally speaking, risk and reward move together; greater risk means greater reward. Is it possible to increase reward without adding an equal portion of risk? This is where modern portfolio theory (MPT) comes in.
The objective of MPT is to find the greatest possible return for any given amount of risk. To greatly simplify the concept, MPT looks at the volatility of each investment in comparison with its current pricing and actual value, and carefully considers how each asset affects the portfolio as a whole. Each addition to a portfolio is analyzed and calculated to determine whether the portfolio’s risk and return is positively affected.
An appropriate asset allocation that offers exposure to several different types of investments will help you meet your financial goals while keeping your investments in balance and your asset allocation on track.
If you have any questions regarding your portfolio’s asset allocation or need help with designing an appropriate asset allocation, contact your investment advisor today.