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Asset Allocation and Diversification

valid until: 05 Jun 2021date published: 05 Jun 2020

Asset Allocation and DiversificationThe term asset allocation is often used to describe a money management strategy that defines how capital is distributed within an investment portfolio and Forex Signals . This usually includes specifying the amount of the portfolio that should be distributed to different asset classes, or broad types of investments such as stocks, bonds, commodities, and cash. The goal of asset allocation is to improve the mix of investments in different asset classes in order to maximize the return on the investment portfolio while minimizing potential risks, based on the investor’s time frame, risk tolerance, and long-term investment goals. There is evidence to suggest that certain classes of assets work better or worse depending on economic conditions, market forces, government policy, and political influence. The goal of an asset allocation strategy is to define these terms and allocate resources appropriately.Free Forex Signals The concept that is closely related to asset allocation is diversification, and in practice these terms are often used interchangeably. However, asset allocation is primarily concerned with capital allocation in different asset classes. For example, a typical asset allocation strategy might dictate that your portfolio must invest 50% in stocks, 30% invest in bonds, 10% in commodities, and 10% in cash. Diversification is usually associated with capital allocation within these asset classes. For example, within allocating shares to the same portfolio, investments can be allocated to 50% of shares of large companies, 20% of shares of medium-sized companies, 10% of shares of small companies, 10% of international shares, and 10% of market shares Emerging. The concept of diversification involves the allocation of assets within individual asset classes - while risks are distributed among asset classes in the overall portfolio, diversification reduces the risk within each asset class.Free Forex Signals Asset distribution dateUsing asset allocation strategies as a form of risk management is not a new concept. The idea of not to put all your eggs in one basket is something we learned when we were young and lived in for thousands of years. However, the term asset allocation was not present in the investment community until recently. Even before the emergence of modern financial markets, people understood that one's assets must be divided between different categories such as land, business ownership, and (cash) reserves. Until the mid-twentieth century, this concept of asset allocation as a fact of life remained relatively unchanged.Free Forex SignalsSo what has changed to create the asset allocation models that we know today? In 1952, an American economist named Harry Markowitz wrote a paper in the finance magazine called Portfolio Selection, in which he developed the first mathematical model that emphasizes volatility in the portfolio by combining investments and different yield patterns. This paper was the basis for what would have become a standard in portfolio management known as modern portfolio theory.Before Markowitz contributed to asset allocation to equity portfolios, diversification was a process that focused on the yield and risk characteristics of individual securities regardless of how the returns relate to each other. After Markowitz invented his mathematical models for wallet construction, his ideas soon became accepted in academia. A large number of research papers have been published to verify the benefits of asset allocation and have quickly become popular with financial professionals as well.Free Forex Signals In 1974, the Employees Retirement Income Guarantee Act (ERISA) was enacted as a federal law setting minimum standards for investment allocations in pension plans. After ERISA became law, asset allocation and modern portfolio theory became standard practices for portfolio managers required to comply with the law when allocating invested capital in pension plans.the best Free Forex SignalsModern Portfolio Theory and Concepts (MPT)The modern portfolio theory (MPT) has greatly influenced the way investment portfolio managers create portfolios. The concept of MPT is fairly straightforward. However, it requires the investor to make several assumptions about the financial markets; In addition, the mathematical equations used to calculate correlation and risk can be somewhat complicated.the best Free Forex SignalsThe basic premise of MPT is simple: by bringing together securities of different asset classes that are not closely related, one can reduce portfolio volatility and increase risk-adjusted performance. In other words, a combination of unrelated assets will lead to the most efficient portfolio - the portfolio that yields the greatest return for a given amount of risk.the best Free Forex Signals Returns of assets do not have to be passively or even disconnected to provide diversification benefits, as they cannot be fully correlated. For example, in the chart below, international stocks (as represented by the EAFE index) are compared to US domestic shares (as represented by the S&P 500). Using the correlation coefficient, you can see that the relationship is positive for most of the five-year period. However, it is not completely correlated (i.e. a correlation coefficient of 1.0).Free Forex SignalsThere are periods of low to negative correlation received during this time period. By investing in both US domestic stocks and international stocks, general volatility can be reduced as the correlation varies enough between the two asset classes to provide meaningful diversification. The MPT concept demonstrates that adding a volatile asset to a portfolio can reduce overall volatility if returns have differences in correlation. This is an intriguing concept - portfolio volatility can generally be minimized by bringing together asset classes together which, in themselves, have returns with higher volatility.the best Free Forex SignalsThe assumption is that by combining asset classes that are not fully correlated when one asset’s value declines, the value of another asset in the portfolio increases over the same time period. So even if all asset classes themselves are very volatile, when combined into one portfolio, volatility is reduced.the best Free Forex SignalsThe extreme example of negative correlation is shown in the following chart of the US dollar compared to the price of gold over the past five years. If the investor had invested in these two volatile assets together, the overall volatility of the portfolio would have decreased significantly due to the negative correlation.As mentioned earlier, the MPT requires that the investor make some assumptions about financial markets in order to calculate the potential benefits of the theory. The main assumptions are that ...Financial markets are efficient.Market returns are distributed randomly.Investors are rational.These assumptions are necessary to accurately calculate standard deviation and correlation using the normal distribution or bell curve.By using the normal distribution function (which determines risk as the standard deviation of return), the risk and the correlation can be calculated mathematically for individual assets as well as portfolios. However, if the markets are in fact not fully effective, the returns to the assets do not necessarily follow the normal distribution and the correlation accounts and risks used in the MPT may be flawed. With the extreme market volatility seen during the dot com bubble in the early 2000s and the 2008-2009 financial crisis, the assumptions used in the MPT have been largely examined.free forex signals presents special offer open trading account with one of the best forex brokers and GET FREE forex Signals via SMS, Email and WhatsApp SIGN UP FOR A FREE TRIAL To Access FREE Forex Signals in the Members Area START FREE 30 DAYS TRIAL on https://www.freeforex-signals.com/

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Asset Allocation and Diversification
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