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Appropriately setting your personal investment asset allocation in line with your personal investment risk tolerance is a critical decision for every individual investor.
Because the average risk-averse investor holds the average portfolio asset allocation, this becomes the starting point in determining how a specific individual’s portfolio might diverge from that average allocation. Asset allocation can be viewed as an extension of the diversification principle to multiple types of assets, such as equities versus fixed income securities. Asset allocation is also how you blend your personal risk preference assessment into your portfolio.
Appropriately setting your personal asset allocation in line with your personal risk tolerance is a critical decision for every investor. The percentages that are allocated to various asset classes tend to change slowly over time, so it is important to get it right at the outset.
An individual’s risk preference relative to the average investor influences the asset allocation that will be chosen.
Because the average risk-averse investor holds the average portfolio asset allocation, this becomes the starting point in determining how a specific individual’s investment portfolio might diverge from that of the average investor’s asset allocation. For mid-2004,The Skilled Investor performed a detailed analysis of personal financial asset ownership held directly and indirectly by institutions for the benefit of individuals to understand the overall asset allocation percentages of the major financial asset classes. Because the relative values of financial asset may change over market and business cycles, mid-2004 was chosen arbitrarily as roughly the mid-point of the most recent economic and market expansion.
Concerning the average portfolio of the average investor, The Skilled Investor reviewed detailed data from the US Federal Reserve Bank which tracks total personal assets across all kinds of personal accounts including brokerage, tax deferred, pension, insurance, trust, and other accounts. The Fed’s June 2004 Z.1 report indicates that total U.S. personal financial assets were approximately $26.9 trillion dollars. In total in mid-2004, the percentage allocation across the major financial asset classes was 26.9% in cash and equivalents, 18.9% in fixed income, and 54.2% in equities.1
For purposes of comparison, the Investment Company of America’s (ICI) end of 2004 estimate of total US domiciled mutual fund assets, which is a subset of the personal assets that the Fed tracks, totaled $7.5 trillion dollars.2 The percentage allocation [...]