How asset allocation funds can help you diversify your portfolio
Editorial staff, J.P. Morgan Wealth Management
- An asset allocation fund is a type of exchange-traded fund (ETF) or mutual fund that invests across a variety of asset classes (such as stocks and bonds) to provide a diversified portfolio that can potentially reduce risk.
- Risk-based asset allocation funds align your risk profile with a target amount of portfolio risk based on the percentage of the underlying investments held in the fund.
- Consider choosing a fund that’s right for your goals and risk tolerance, and consider the fees before you invest.
How allocation funds can help you diversify your portfolio
Asset allocation funds are a potentially attractive option for investors seeking a way to maintain a diversified portfolio that’s aligned with their goals, typically with the benefit of professional expertise. But what are asset allocation funds exactly? How might they fit into your investment strategy and, more importantly, how do you choose the right one?
What is an asset allocation fund?
An asset allocation fund is a type of investment fund that focuses on diversification across multiple asset classes. Asset allocation funds often combine a variety of investments like equities, fixed income and cash or cash equivalents in one portfolio. The composition of these funds may vary, adapting to different investment strategies and market conditions. While asset allocation funds sometimes aim to balance risk through this diversification, some may adopt more aggressive strategies that focus more on maximizing returns across various asset classes. Thus, asset allocation funds allow investors to access a broad range of investments within a single fund, aligning with their individual investment goals and comfort levels.
Types of asset allocation funds
As discussed above, asset allocation funds come in various forms, each one catering to specific investor goals and market strategies. Let’s go over three common types, often grouped as risk-based funds, and then look at one more type of asset allocation fund geared toward specific time horizons.
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Aggressive
Aggressive asset allocation funds typically allocate a larger portion of their portfolio to equities and aim for higher growth potential with higher volatility and risk. Aggressive asset allocation funds might invest in high-growth sectors, emerging markets or stocks deemed to have significant potential for appreciation. Because of their high growth prospects – and higher risk – these funds might be better-suited for investors with longer time horizons and a higher risk tolerance.
Balanced
Balanced funds generally seek a somewhat even mix of risk and reward with a diversified mix of stocks and bonds. These funds might adjust the balance in favor of one asset class over the other depending on market conditions and economic forecasts. A balanced asset allocation fund aims to offer investors a potential steady income and a stable growth trajectory with potentially reduced volatility, which may appeal to an investor looking for a mix of income and appreciation while maintaining a moderate risk exposure.
Conservative
Conservative funds prioritize income and stability, generally focusing on investment grade fixed-income securities and cash equivalents. Some may include a modest allocation to stocks as well. A conservative asset allocation fund might be suitable for those with shorter time horizons, or for investors with a low risk tolerance who seek steady (though typically more modest) returns. For instance, during periods of market turbulence, conservative funds may experience less fluctuation compared to equity-focused funds.
Target-date funds
Target-date funds are tailored to evolve alongside an investor’s age and anticipated retirement date. These funds automatically adjust their asset allocation, shifting from aggressive investments in an investor’s early years to more conservative investments as the set target date approaches. For those who prefer a “set-and-forget" strategy, target-date funds offer a more dynamic approach to hands-off, long-term investment, recalibrating the asset mix to maintain an appropriate risk level over time. This lifecycle investing strategy takes into account the changing risk profile of the investor as they move closer to retirement.
Pros and cons of asset allocation funds
Like any investment, asset allocation funds come with their own set of potential advantages and disadvantages.
Pros
- Opportunity for diversification: Investing in an asset allocation fund may provide you with exposure to a broad range of assets that might be otherwise laborious to manage on your own.
- Simplified portfolio management: Fund managers oversee the daily operations and adjustments in the fund, alleviating some of the active work involved in your portfolio.
- Professional expertise: Your investments may benefit from the professional expertise of a qualified fund manager when navigating market changes.
Cons
- Higher fees: Asset allocation funds may come with higher fees compared to other investment options, primarily due to the active management involved.
- Limited customization: Investors in asset allocation funds often cannot adjust individual asset classes within the fund to suit their personal preferences or market outlook.
Choosing the right asset allocation fund
Your choice of asset allocation fund may significantly impact your investment trajectory. Here are a few factors to keep in mind to help choose the right one for you:
- Investment goals: Consider what you want to achieve with your investments. Different fund types, such as an aggressive fund or a target-date fund, will likely align better with some specific objectives over others.
- Risk tolerance: Many asset allocation funds address specific risk tolerances, so you have a better chance of finding the one that aligns with your personal comfort level.
- Time horizon: The amount of time you have at your disposal to let investments mature or recover from potential market downturns might shape the investment strategies you prefer.
- Fees and expenses: Staying mindful of the fees associated with the specific fund you’re considering may help you more accurately project some of your potential returns.
The bottom line
Asset allocation funds help investors diversify their portfolios while pursuing specific investment goals and investment strategies. There are a variety of funds available, catering to different goals and appetites for risk. Choosing the right fund generally boils down to an honest look at your own preferences and long-term financial objectives. Speaking with a qualified financial advisor may help clarify how an asset allocation fund might fit into your own investment portfolio.
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Editorial staff, J.P. Morgan Wealth Management
