Diversifying assets is one of the most reliable ways investors can protect themselves against market volatility and increase their chances of achieving steady returns. Your particular asset allocation strategy should be based on this need to spread investments across different asset classes. Choosing an asset allocation strategy requires careful consideration of your investment objectives, time horizon, risk tolerance, market conditions and much more.

A financial advisor can help you develop a strategy tailored to your unique financial situation.

How Asset Allocation Works

Asset allocation involves distributing investments among different asset categories, such as stocks, bonds, cash and more. This strategic distribution aims to balance risk and reward and capitalize on growth opportunities. Remember, asset allocation is not a one-time task but a dynamic process. Market conditions, economic changes and personal circumstances can necessitate adjustments in the portfolio.

Stocks, for example, offer high growth potential but come with significant volatility in an unpredictable market. Bonds, on the other hand, provide stability and regular income but for lower returns. Cash and cash equivalents offer the most stability but the least growth potential.

By using diverse asset allocation strategies, you can reduce the impact of a poor performance in any single asset category. One of the key benefits of asset allocation strategies is risk management. By spreading investments across various assets, investors can protect themselves from significant losses.

Diversification within asset classes, such as investing in different sectors or geographical regions, further reduces risk. This comprehensive approach ensures that the investor is not overly exposed to any single market event.

Successful asset allocation requires a long-term perspective. Short-term market fluctuations should not dictate changes in the investment strategy. Staying committed to a well-devised asset allocation strategy can help investors weather market volatility and achieve their financial goals over time.

Types of Asset Allocation Strategies

From strategic and tactical approaches to dynamic and constant-weighting methods, investors have various options to suit their goals, appetite for risk and market conditions.

Strategic Asset Allocation

Strategic asset allocation is a long-term approach where investors set target allocations for various asset classes. They must periodically rebalance the portfolio back to these targets when their holdings drift from their target composition. The aim is to maintain a consistent exposure to different asset classes, benefiting from their historical risk and return characteristics.

Tactical Asset Allocation

Tactical asset allocation allows for a more dynamic approach, providing investors the flexibility to capitalize on market opportunities. While the investor starts with a base strategic allocation, they can deviate from these targets in the short term to exploit favorable market conditions. This strategy requires active management and a keen understanding of market trends, which could mean a financial advisor may be a value-add.

Dynamic Asset Allocation

Dynamic asset allocation is another flexible strategy where the portfolio mix is adjusted continually based on market conditions. Unlike tactical allocation, which focuses on short-term opportunities, dynamic allocation involves ongoing adjustments. It’s designed to reduce risk during downturns and increase exposure during market upswings. This approach is particularly suited for investors who are comfortable with frequent changes and have a solid grasp of market behavior.

Constant-Weighting Asset Allocation

Constant-weighting asset allocation involves maintaining a set proportion of different assets in the portfolio, adjusting them regularly to stick to the initial weights. Unlike strategic allocation, which might rebalance annually, constant-weighting can require more frequent adjustments. For instance, if an investor aims to keep a 60/40 portfolio (60% in stocks and 40% in bonds), they would rebalance whenever market movements cause significant deviations from these percentages.

Insured Asset Allocation

Insured asset allocation is tailored for risk-averse investors who want to ensure a certain level of portfolio protection. This strategy involves setting a minimum portfolio value and adjusting the asset mix to maintain this threshold, especially during market declines like recessions, depressions and corrections. If the portfolio value drops to the predetermined level, the investor shifts to more conservative assets to protect against further losses, thus providing a safety net in volatile markets.

Integrated Asset Allocation

Integrated asset allocation combines elements of both strategic and tactical approaches. It not only considers an investor’s long-term goals and risk tolerance but also takes into account current market conditions to make adjustments. This approach aims to optimize the portfolio by blending the stability of a long-term plan with the adaptability of short-term tactics, making it a comprehensive approach for managing investments.

How Asset Allocations Change by Age

A couple looks over the asset allocation of their retirement portfolio.

As people approach retirement, their asset allocation by age will change to meet new financial circumstances and objectives. For young investors in their 20s and 30s, the primary goal is typically growth. With a long investment horizon, they can afford to take on more risk to achieve higher returns. Therefore, their asset allocation strategies often heavily favor stocks, which, despite their volatility, offer substantial growth potential over time. Typically, these investors might allocate up to 90% – or more – of their portfolio to equities.

As investors move into their 40s and 50s, their focus starts to shift towards balancing growth with stability. At this stage, while they still have a considerable amount of time before retirement, they might want to reduce exposure to high-risk investments to protect the wealth they’ve accumulated. Thus, a typical asset allocation strategy for middle-aged investors might include a mix of 60-70% stocks and 30-40% bonds and cash. This balanced approach aims to continue growing the portfolio while minimizing the potential impact of market downturns.

In the decade leading up to retirement, typically in their 60s, investors often shift their asset allocation strategies to prioritize the preservation of capital. The closer they get to retirement, the less time they have to recover from significant market losses. Therefore, they might allocate around 40-60% of their portfolio to stocks, with the rest in bonds and cash. This conservative strategy helps safeguard their savings while still providing some growth potential to combat inflation.

Once investors reach retirement, the primary goal shifts to generating a reliable income stream while protecting their wealth. At this stage, asset allocation strategies usually emphasize income-producing investments and preserving capital.

Generating your quiz…

How to Determine Your Risk Tolerance

Risk tolerance refers to how much market volatility and potential loss you’re willing to accept in pursuit of investment gains. It varies widely from person to person and depends on multiple factors, including your age, financial goals, income stability, time horizon, and overall temperament.

One way to get a clearer picture of your risk tolerance is to complete a self-assessment checklist or risk questionnaire. Many brokerages and financial advisors offer risk quizzes to help investors categorize themselves as conservative, moderate or aggressive. Ask yourself the following:

How would I react if my portfolio lost 20% in a short period?
Am I more focused on preserving capital or growing my investments?
How long can I keep my money invested before needing to access it?
Do I have other ways to make extra income if my investments underperform?

It’s also important to understand the difference between risk tolerance and risk capacity. Risk tolerance is your emotional ability to handle losses, while risk capacity is your financial ability to absorb them. For example, a retiree might have a high emotional tolerance for risk but low risk capacity due to limited income. Aligning both is crucial when crafting your investment plan.

Rebalancing: When and How to Do It

No matter how carefully you design your asset allocation, market fluctuations will eventually cause your portfolio to drift from its original targets. Rebalancing is the process of realigning your portfolio back to your intended asset mix. This keeps your risk level consistent and helps ensure your long-term strategy stays on track.

There are two primary methods for rebalancing:

Time-based rebalancing involves rebalancing your portfolio on a fixed schedule, typically quarterly, semiannually, or annually.
Threshold-based rebalancing triggers an adjustment when an asset class deviates from its target allocation by a set percentage, often 5% or more. For example, if your target is 60% stocks and your portfolio grows to 67% stocks, you might sell some equities and buy bonds to restore balance.

When rebalancing, it’s important to consider tax implications, especially in taxable accounts. Selling assets can trigger capital gains taxes. To reduce tax liability, investors may:

Rebalance within tax-advantaged accounts like IRAs or 401(k)s
Use new contributions to buy underweighted assets
Harvest tax losses to offset gains

Regular rebalancing is a critical part of portfolio maintenance and can help investors avoid taking on unintended risk as markets move over time.

Bottom Line

An investor reviews her portfolio's asset allocation.

Diversification is key, both in how asset strategies operate and in the number of strategies available to you. By spreading investments across various asset classes, investors can balance their returns according to their risk tolerance. Moreover, a strategic asset allocation aligns investments with long-term financial objectives. Regularly reviewing and adjusting asset allocation is one of the primary ways investors protect their portfolios from market volatility.

Portfolio Management Tips

While “timing the market” seems like a good idea in theory, it’s practically impossible to do perfectly. Given that no investor possesses complete foresight into market fluctuations, consistently purchasing at the market’s lowest point is nearly unachievable. Additionally, researchers at Schwab say the benefits of achieving perfect timing are relatively minor compared to the risks of potentially mistiming investments, which are considerably greater.
A financial advisor can help you make strategic decisions within your portfolio and manage your investments according to your financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.