As each asset class poses different levels of risk and return, it is crucial for investors to diversify across the board, allocating their investments into a wide variety of assets such as cash, bonds, stocks, real estate, and alternative investments to achieve proper diversification.
For example, equities typically offer the highest potential return but also present the highest level of risk. Hence, it is ideal to invest in a combination of more volatile but high-yielding assets such as equities, and more stable but low-yielding investments like bonds and fixed income.
Nevertheless, there is no one-size-fits-all, universal solution when it comes to allocating assets within an investment portfolio as each investor is unique and has different financial goals and risk appetite. When trying to determine the right asset allocation that will enable them to achieve diversification, investors need to consider the following key factors:
Age
Younger investors should consider allocating a bigger portion of their investment to stocks, since time is on their side to reap the benefits of the compounding gains of stocks and ride out any periods of volatility in markets. Older investors may want to focus more on fixed income assets that are less prone to volatility and produce stable returns such as bonds, as they are nearer to retirement and may not want to take on unnecessary risk.
Risk Appetite
Conservative investors who prefer to preserve their capital and avoid market fluctuations should consider a higher allocation to bonds and other low volatility investments, while those with a higher risk appetite may opt for a higher exposure to equities in their portfolios.