You may have heard that asset allocation is the primary driver of investment returns. That’s because it’s true. But what does that mean, how do you choose the right asset allocation, and what 2023 asset allocation ideas are there for your portfolio (hint: the 60/40 portfolio is back)?
I got into this and a lot more with the gentleman responsible for building our portfolio allocations at Heritage Financial, Michael Waldron, our Director of Portfolio Management in the latest episode of the Wealthy Behavior podcast.
Michael explains that asset allocation starts with understanding how much risk you are willing to take in your portfolio and how much risk you can take based on your financial plan. Building a detailed financial plan is an important starting point. Starting with risk also helps you avoid sequence of return risk in retirement.
Then you need to choose asset classes that based on risk and return expectations deliver the risk-adjusted returns you’re looking for and provide a diversification benefit from each other.
2023 Asset Allocation Ideas
Michael then shared what asset classes look attractive going forward based on his research and capital market assumptions work.
The 60/40 portfolio is back!
Traditional asset classes have higher return expectations, so it’s time for long-term investors to be excited about stocks and bonds.
Bond yields have increased by a few percentage points, so fixed income return expectations are now 3% higher.
Earnings yields on stocks are up about a percent primarily due to the 2022 stock market sell-off.
Accordingly, alternative investments and real assets are less attractive and you may want to reduce exposure there.
International stock markets are attractive, but there are additional risks there so a strong asset allocation methodology will cap investments in those areas.
Be sure to listen to the end as Michael explains:
- Why inflation expectations year over year have decreased
- How investors can build their return expectations starting with nailing down expectation inflation using bonds and then a method for doing it with stocks and bonds
- Why you should cap exposure to some asset classes to avoid outsized risks
- Taking the noise out of your portfolio expectations
According to a well-known study asset allocation is responsible for over 90% of a portfolio’s return. With the success of your financial future on the line, how do you determine what asset allocation is right for you?
In this episode of Wealthy Behavior we discuss the important role capital market assumptions play in determining the appropriate asset allocation for each client and the factors that go into allocation adjustments throughout the year. We also discuss what factors we believe will drive asset class returns in 2023.
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