Basics     Explainers

Asset Allocation (Part 1)

POSTED ON JULY 17, 2020     Andoy Beltran

It’s human nature to want the highest possible returns from your investments.

 

But it is also a known fact that when it comes to investing: The lower the risk, the lower the return; and the higher the risk, the higher the return.

 

Investors should think twice when they get pitched an investment outlet or a business model which promises to bear low risk, and at the same time, provide high returns. But it’s comforting to know that there is something we can do to help our portfolio get the highest possible return with the lowest possible risk.


What is asset allocation?

Asset allocation is the strategy of distributing funds across various asset classes, each with its own risk, return and time horizon details. It is designed to help you optimize your returns while minimizing risks.

 

Asset allocation doesn’t just make it possible for you to distribute the risk of losing money, it also distributes your source of income. But it isn’t a one-shot thing. It’s an ever-evolving process because a lot of factors–economic, business, political landscapes–are dynamic.

 

That means your asset allocation strategies need to adapt to your lifestyle and the changing times.

You have to embrace the fact that it’s not optimal to put all your money in the asset class with the lowest potential risk, because that means you’re also putting all your money in the asset class with the lowest potential return.

You have to embrace the fact that it’s not practical to put all your money in the asset class with the highest potential return, because that means you’re also putting all your money in the asset class with the highest potential risk.

The mere fact that you’re budgeting your own money, and taking care of your savings and investments, makes you your very own fund manager.

And that’s a role you need to take very seriously.

 
What assets can I invest in?

Cash/Money Market is a popular choice. You run very little risk of losing the value of your money, and when deposited it is covered by the government-owned Philippine Insurance Deposit Corporation (PDIC) for up to P500,000 per depositor per bank.

 

However, it shouldn’t be the only thing to consider. If most of your money is kept in cash, you run the risk that inflation will leave it worth less (but not completely worthless). In the long run, that amount may not be able to buy the same goods and services as it does today.

 

Bonds are also an option. They are loans to a company or the government for a fixed number of years, and they pay you fixed interest. The returns from bonds are better than cash, because they give a fixed stream of income through coupon payments as well as giving you back your original amount at the end of maturity. Bonds can also experience capital appreciation, when you sell them for more than you paid for them.

 

When it comes to maturities, there are short-term bonds (called bills), medium-term bonds (called notes) and long-term bonds (just called bonds). Ideally, the longer the term, the higher the interest rate.

 

Keep in mind that bonds are a form of debt, so you will always run the risk of not getting repaid. Between corporate and government bonds, the latter is safer; if worse comes to worst, the Bangko Sentral ng Pilipinas (BSP) can always print more money to pay off its obligations. This is also why corporate bonds give higher returns than government bonds.

Stocks are a third option. They allow you to buy ownership in a publicly listed corporation. Of course, not all businesses are worth buying.

 

Some of these are small-cap stocks that have good growth potential but also risk failing because of competition or a challenging business environment. Others are mid-cap stocks that are better established than smaller counterparts, while Blue Chips (shares of highly traded, liquid, stable companies) are a less risky but more expensive option.

 

Like bonds, stocks can grow in two ways. With capital appreciation, you can buy stock low and sell high. This can happen quickly or after a long period. And with dividends–or profit sharing–because you are a part-owner of a company, you receive a share of its profits. This makes choosing a profitable company even more important.

 

Unlike bonds, stocks don’t have maturities. As long as the company is publicly listed, you can stay invested in its shares.


What should I choose?

Investing is never a case of one asset type being better than another. Investing is spreading your wealth across various outlets you understand and allowing them to work for you harmoniously. It’s not a case of stocks versus bonds versus cash. Instead, it should be stocks + bonds + cash, working hand in hand.

 

Having exposure in the money market (deposits), the bond market (bonds) and the stock market (stocks) will help you get liquidity, stability, growth and appreciation in your portfolio.

 

The liquidity comes from the easily withdrawable aspect of money in your deposit account or money market funds. That’s why these are great for housing your emergency fund or operational fund, which is money that you’re sure of spending within the next 12 months.

 

The stability comes from the potential capital appreciation of bonds (especially in a low-interest environment), while also giving you fixed income through periodic coupon payments.

 

The growth comes from the co-ownership of publicly listed corporations when you buy stocks. If the company makes money, the share price may go up. You could receive a share of the profits via dividends, too.

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