Asset Allocation: What Determines 90% of Your Investing Results

The 90/10 Rule of Asset Allocation.

When it comes to investing and building wealth, most people focus on the wrong things. They obsess over picking the "perfect" stocks, the hottest mutual funds, or the latest cryptocurrency craze. But the truth is, these things matter much less than you might think.

In fact, according to a study by financial researcher Gary P. Brinson, your portfolio performance is actually determined 90% by asset allocation and only 10% by the specific investments you choose within each asset class.

So, what is asset allocation and why is it so important?

Asset allocation is simply the process of dividing your investment portfolio among different asset classes, such as stocks, bonds, gol and cash. The goal is to diversify your holdings and reduce risk, so that if one asset class takes a hit, the others can help balance out the losses.

There are several different asset classes to choose from, each with its own set of risks and rewards.

Stocks, also known as equities, represent ownership in a company and offer the potential for growth through dividends and capital appreciation (stock price go up). However, while they are one of the best performing asset classes historically, they are also more volatile than other asset classes and can fluctuate significantly in value. Understanding the stock market volatility, and mentally preparing yourself for a -20-30% drop is crucial for long term success.

Bonds, or fixed income securities, represent a loan to a company or government. They offer a fixed rate of return but are generally less risky than stocks. Usually bonds pay interest twice a year, and at the end of the bond contract (1-20 years usually) the initial investment is paid back to the holder. This makes them a safer investment, however due to recent interest rates at historically low levels bonds also pay quite low currently in the 1-3% range.

Cash, or cash equivalents, includes things like money market funds and short-term government bonds. They offer low risk and low returns (0-1%), but can be useful for short-term goals or as a buffer during volatile markets.

Real estate is property consisting of land or buildings. This can range to a primary household, a rental property, all the way to apartment buildings, and commerical buildings.

Commodities, such as gold and oil, are also considered separate asset classes, and can be a very complex market.

Cryptocurrencies, are digital or virtual currencies that live on the internet, using cryptography and operate on a decentralized system called blockchain. They are not backed by any central authority and are highly volatile. Examples include Bitcoin, Ethereum, but there are thousands.

So, why is asset allocation such a crucial part of investing?

First and foremost, it helps you manage risk. By diversifying your portfolio, you can reduce the impact of any one investment on your overall returns. For example, if you have a portfolio heavily weighted in tech stocks and there is a market crash in the tech sector, your portfolio will take a hit. But if you have a mix of asset classes, the losses in one area can potentially be offset by gains in another.

Asset allocation can also have a big impact on your long-term returns. By including a mix of asset classes, you can potentially capture higher returns and reduce the overall volatility of your portfolio.

Of course, this doesn't mean you should blindly throw your money into every asset class and hope for the best. It's still important to do your research and make informed decisions about your investments. But don't get too caught up in trying to pick the "perfect" stocks or mutual funds. The real key to investing success is having a well-thought-out asset allocation plan.

So, the next time you're tempted to put all your money into the latest hot stock or fund, remember the 90/10 rule: asset allocation is key.