Asset Classes for Retirement Investments
When it comes to retirement investments, it’s paramount to construct a portfolio that can deliver a reasonable return with acceptable risk. This is where the asset allocation comes into play. One should carefully choose funds that represent asset classes. These asset classes should deliver reasonable returns in the long term. Furthermore, by carefully weighting allocations to them, one can balance out risk because of the correlation of these assets (funds). Intuitively, by correlation we mean when one asset price zigs, others zag or at least they are not completely in sync to fall together.
In a word, the criteria to choose asset classes should be
- Returns: these asset classes should deliver reasonable long term returns.
- Risk: they are more or less uncorrelated. Ideally, they can hedge each other. Individually, they should pose as little risk as possible
Asset allocation (weighting in different assets) is the one of the main factors that affect a portfolio’s overall return and risk. In a study of hundreds of US pension funds by Gary Brinson, Randolph Hood and Gilbert Beebower, it was found that asset allocation is responsible for over 90% of variations in portfolio return. Even though it’s still arguable on how much asset allocation impacts on a portfolio’s return, it’s very intuitive and compelling that asset weighting (allocation) is one of the main determining factors. One thus needs to take asset class selection seriously.
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