Asset allocation sits at the heart of every well constructed investment portfolio. Below, we explore what asset allocation means, why it matters, and how it shapes long term outcomes…
Commonly, people focus on finding the right investment; the best share, the top-performing fund, or the asset class that has delivered the strongest recent returns. But decades of evidence from markets around the world point to a more important truth: how you spread your money across different types of investments has a greater influence on your long-term financial outcomes than any single investment decision you will ever make. This is the essence of asset allocation, and it is the foundation on which sound investment portfolios are built.
The principle behind asset allocation is straightforward. Different types of investments: shares, bonds, property, and alternatives such as infrastructure and commodities respond differently to the same economic conditions. When share markets are falling, bonds may be holding their value. When inflation is rising, property and infrastructure revenues often increase alongside it, helping protect your purchasing power. By holding a mix of asset types that do not all move in the same direction at the same time, you reduce the chance that any single event; a recession, a spike in interest rates, or a global shock causes serious and lasting damage to your overall wealth. In short, diversification does not eliminate risk, but it is the most reliable tool available for managing it.
Getting asset allocation right is not a one-size-fits-all exercise. The right mix depends on your personal circumstances. How long you plan to invest, how much short-term volatility you can tolerate without losing sleep or making poor decisions, and what you ultimately need your money to do for you. Asset allocation is ultimately about combining different types of investments in a way that supports your goals through changing market conditions.
The term “asset allocation” refers to how an investor allocates their investable money across the different type of assets. In setting the stage, it’s helpful to know the different types of assets that can be included within an asset allocation. These include but are not limited to: NZ and international fixed income securities, NZ and international listed property, Australasian equities, international equities, and alternative assets.
The power of diversification as a risk management strategy is best illustrated by Table 1. below, produced by Russell Investments, which shows the annual performance of each asset class since 2016. As the table demonstrates, returns vary significantly from year to year, with no single asset class consistently outperforming the others. While US Large Cap Equities and Global Equities have been the most reliable long-term performers, the variability across years reinforces the benefit of investing beyond New Zealand’s relatively small market.
By combining a range of asset classes in proportions that align with your tolerance for risk, you can reduce the impact of any one asset class underperforming while still participating in long term market growth. This is reflected in the “Balanced” portfolios shown in brown, which demonstrate how diversification smooths returns over time.
A well-structured allocation brings these elements together to create a portfolio that is positioned for growth, supported by stability, and resilient over time.
This article forms part of a broader series on asset classes. You can find the full set of articles in the Insights section of our website as they are released.
Table 1. Performance Table
