Asset allocation and security selection: what is the difference?

Asset Allocation and Securities Selection: An Overview

Asset allocation and security selection are key components of investment strategies, but they require separate and different methodologies.

Asset allocation is a broad strategy, which determines the portfolio of assets held in the investment portfolio according to the investor’s risk status and investment objectives to obtain the best risk-return balance. Security selection is the process of identifying individual securities in the specific asset classes that make up the investment portfolio.

Key points

  • Asset allocation determines the portfolio of assets held in the investment portfolio, and security selection is the process of identifying individual securities.
  • Asset allocation aims to build a portfolio of unrelated assets based on risks and returns, and minimize portfolio risks while maximizing returns.
  • Securities selection is carried out after asset allocation is determined, while assets such as index funds and ETFs are used to achieve allocation goals.
  • The efficient market hypothesis shows that asset allocation is more important than securities selection when formulating a successful investment strategy.

Asset allocation

As we all know, different types of assets often behave differently in response to market conditions. For example, when the stock market performs well, bonds tend to perform poorly, or when large-cap stocks outperform the broader market, small-cap stocks may underperform.

In terms of investment, these assets are irrelevant. Asset allocation is the practice of mixing unrelated assets together to find the best balance of risk and return based on the investor’s investment status. Asset allocation aims to minimize the risk of the investment portfolio while maximizing the return of the effective investment portfolio.

For investors looking for higher returns and willing to take more risks, asset allocation is more biased towards stocks than bonds. An 80/20 or 90/10 combination of stocks and bonds would be considered an aggressive allocation. In the stock part of the investment portfolio, asset allocation can be further divided into aggressive growth stocks, emerging markets, small-cap stocks, mid-cap stocks, and large-cap stocks. More conservative investors may choose a 60/40 or 50/50 combination of stocks and bonds and allocate more large-cap stocks.

Safe choice

After formulating an asset allocation strategy, you must select securities to construct an investment portfolio and fill in allocation goals based on the strategy. Most investors usually choose from mutual funds, index funds, and exchange-traded funds by matching the fund’s investment objectives with the various components of its asset allocation strategy.

For example, conservative investors may consider seeking capital preservation funds in addition to capital appreciation, while more aggressive investors may consider strictly seeking capital appreciation funds.

Passive investors tend to focus on low-cost index funds that try to replicate stock index components. Conservative investors may consider index funds that follow the Standard & Poor’s 500 (S&P 500) index or dividend-paying stock index, while moderate investors may allocate smaller allocations of S&P 500 index funds to mid-cap or small-cap stocks Mixed use-cap funds.

Active investors looking for opportunities to outperform the index can choose from thousands of actively managed funds. Larger investors with more than $1 million in assets may choose to work with money managers who choose individual stocks to build a portfolio.

special attention items

Asset allocation assumes that there is uncertainty in the future direction of asset prices, and based on market and economic conditions at any given time, some assets will increase, while others will depreciate. Asset allocation is more about managing risk and volatility than about managing performance. The selection of individual securities assumes an understanding of the future, and investors have some information that can provide information about the direction of future prices.

The efficient market hypothesis put forward by William Sharp shows that stock prices fully reflect all available information and expectations, which will prevent investors from continuously taking advantage of mispriced stocks. Sharp concluded that it is best for investors to choose appropriate asset allocation and invest in a diversified portfolio of passively managed funds.

Although asset allocation and selection of appropriate securities are both important to investment strategies, it is more important to target the correct asset allocation, which can then be filled with index tracking funds.


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