Asset Allocation: An Illustration from Warfare
If you had to describe investing, assets or “asset allocation” to someone, which metaphors or illustrations would you use to describe them, and show why they’re important?
One illustration some of our financial advisers in Grantham quite like comes from military history. Think of ancient Rome, for instance, and how different units or “troop types” (i.e. military assets) were used in various battles to achieve victory.
For instance, attacking an enemy army only with heavy infantry might sound sensible (strong armour, deadly weapons etc.). However, what good would this do against an enemy comprised entirely of horse archers, who could then simply outmanoeuvre and slowly pick them off?
For reasons such as this, Rome and other historical empires partly rose to success because they used different military assets together (infantry, spearmen, cavalry etc.) to achieve crucial objectives. A very similar comparison can be drawn when it comes to investing.
Investing might not be the same as warfare, but both involve identifying a set of objectives and then gathering your assets together under a strong strategy to achieve them. In the latter, your “assets” include things such as troop types, military leaders and the like. In the former, your assets comprise terms such as “equities”, “bonds” and real estate investment trusts (REITs).
Relying on one sole investment to achieve your goals is a bit like going into battle with just one unit type. Doing so would leave you vulnerable in certain scenarios, rather than having other assets at your disposal to counter threats (e.g. volatilities or decline in certain marketplaces).
So, what should your ideal “blend” (or allocation) of investment assets be? That depends.
Again, similar to a traditional battle, what you choose to include in your asset allocation depends on important factors such as the environment you are stepping into, the precise goals you want to achieve and the resources at your disposal.
In this short guide, we’ll be sharing a broad idea of what different “asset allocation models” might look like – depending on your goals and risk tolerance. Please note that this content is not to be taken as financial advice; it is for inspiration and information purposes only.
To receive regulated financial advice regarding your own investments, please speak to an independent financial adviser.
Different Investor “Battle Plans”
When you speak to a financial adviser about starting to invest, they should help to establish your “risk appetite” or risk profile. This is the mixture of your risk tolerance and your capacity for loss. Your risk tolerance is your willingness to put your money towards investments which carry a higher potential return, as well as a higher chance of losing value. Your capacity for loss is your financial resilience to sustain losses without it affecting your ability to meet the costs of your lifestyle.
If you have a lower risk tolerance and your goal is simply to preserve the wealth you currently have, then this will influence the “asset allocation” your adviser recommends for your investment strategy. In military terms, this is the equivalent to “digging into” a defensive position and protecting the territory you currently hold, rather than venturing out to expand your borders.
To achieve this kind of “defensive” investment goal, the asset allocation might look something like the following (note: this is an example; your own allocation might look different):
- 70-75% fixed income securities (e.g. UK government bonds).
- 15-20% equities (e.g. investments in company funds).
- 5-15% cash
However, suppose your investment goal is to grow your wealth over a long time period. You are prepared to take more risks with your money and have the stomach to cope with potential short-term losses. The aforementioned example of asset allocation would likely be unsuitable for your needs. To draw on the military illustration once more, you need assets which will allow you to expand rather than consolidate.
To achieve this kind of “aggressive” investment goal, the asset allocation might look something like the following (again, this is an example; your own allocation might look different):
- 70-85% equities
- 5-10% fixed income
- 5-10% commodities
- 5-10% cash
Of course, these are two examples where each sits quite far on different sides of the risk/potential return spectrum. There are asset allocation plans which sit on various points between the two. The precise blend of assets you eventually settle on will very much depend on your unique financial goals and circumstances.
There are many other similarities between warfare and investing, which are worth mentioning here as we conclude:
- A plan for when the plan falls short. As in warfare, a financial/investment strategy does not guarantee that you will meet your goals. However, it does give you the best chance possible. The best plans, moreover, will also help to give you a plan of what to do with your investment strategy when “Plan A” does not transpire as you hoped.
- Advice. Some of the best military leaders in history were personally brilliant in their strategic abilities, but they also tended to have a close team of advisers to help them make good decisions. After all, even the wisest of us have blind spots which trusted friends, family and colleagues can help us mitigate. This is a strong reason to consider gaining the counsel of an independent financial adviser, for your own investment plan.