At a Glance:
- Diversification in investing reflects the amount of same asset class holdings in your portfolio.
- Asset allocation is the way in which assets are distributed within your portfolio to align with your goals and objectives.
- An experienced wealth manager can guide you in implementing diversification strategies along with asset allocation strategies to achieve adequate risk exposure for your financial situation.
As a top-level executive, you have likely sat down with an investment advisor at some point in your life. Having done so, you know that most advisors will tell you that asset allocation and diversification are important strategies to implement in your financial portfolio. These strategies correlate the risk you take in your portfolio with your risk tolerance, as well as limit your exposure due to concentration in one asset, such as an individual stock. While this all sounds great in theory, many advisors fail to truly explain asset allocation vs. diversification and why a C-suite level executive needs to know and understand the difference.
When my team and I sit down with a new executive client, we know that, inevitably, we will uncover a large concentrated position in their employer’s stock. This is to no fault of their own, but rather a compliment to them that they have grown their company over time to the point where they have increased share prices and thus increased their stock position.
The problem with this growth is that they have inadvertently become less diversified than most advisors would like to see. But, if they have become less diversified, does it mean they have thrown off their asset allocation? By further explaining asset allocation vs. diversification, we can better answer that question.
Asset Allocation vs. Diversification: Basic Differences
While asset allocation and diversification are often used in the same sentence, they are very different strategies. Diversification in investing reflects the amount of same asset class holdings in your portfolio. For example, of your stock asset class holdings, do you own five stocks or 500 stocks? The larger the number of holdings, the more diversified your position.
Asset allocation is the way in which those assets are distributed within your portfolio to align with your goals and objectives. This allocation is based on age, risk tolerance, income needs, asset base, and more. Asset allocation is typically measured in percentages according to the asset classes in which your money is invested.
Diversification strategies are implemented hand-in-hand with asset allocation strategies to offer clients exposure to risk that fits their risk tolerance while minimizing downside potential due to the faltering of one or more individual holdings.
Deeper Dive: Asset Allocation
When it comes to asset allocation, the major asset classes that most investors will find themselves in are stocks, bonds, cash, commodities, and possibly real estate (sometimes through a real estate investment trust and sometimes held physically). For example, if you are nearing retirement, you might find yourself invested 50% in stocks, 35% in bonds, 10% in real estate, and 5% in cash or money market accounts. This is a hypothetical allocation, and you should work with your advisor to determine what type of allocation works best for you.
The possibilities of asset allocation strategy are truly endless. There are, however, some questions that, when asked by and reviewed with an experienced executive financial advisor, can help you find the best asset allocation mix for your unique situation.
- What is your current risk tolerance?
- What is your current age?
- What does your retirement timeframe look like?
- What is the intent for the money you have invested?
- What is your income need now and later in life?
- Are your focused more on preserving your capital or liquidating your capital?
These types of questions can help you and your financial advisor better understand your situation and goals so that your asset allocation will reflect and complement them.
Deeper Dive: Diversification
While asset allocation takes an overarching view of the different types of assets in your portfolio, diversification involves the number of each of those assets within your portfolio. The concentration of these assets can affect your potential returns, which in turn affects your overall asset allocation strategy.
There are also subcategories of certain asset classes. Take, for example, bonds. When investing in bonds, you could own U.S. Treasury bonds, corporate bonds, municipal bonds, and even high-yield bonds.
Owning different sectors of a certain asset class can offer even more diversification than owning assets from one sector under one asset class. For example, owning 50 stocks that are all related to the oil business would not give you the same diversification as owning all stocks in the S&P 500. However, the more diversified you are, you can start to dilute potential returns now and in the future. This is one of many reasons why you need to work with an executive financial advisor who can help you determine your “sweet spot” of diversification.
As mentioned earlier, diversification can be difficult for top-level executives to implement due to their concentrated stock position they have accumulated with their equity compensation plans offered by their employer. Two of the most effective diversification strategies for highly concentrated stock positions are exchange funds and index proxy strategies. Diversification can help you weather the storm of stock market volatility, but it will look different for each individual investors as there is no one-size-fits-all strategy.
Implementing Diversification and Asset Allocation Strategies
So to answer our question from the beginning, if you have a concentrated stock position and become less diversified, does it throw off your asset allocation? While it depends on your unique situation, the short answer is yes. The larger your stock position grows with your equity compensation, the further off your asset allocation percentages become.
This is why it is so important to work with a trusted advisor on an ongoing basis. An experienced executive financial advisor can help you determine the most effective asset allocation for your portfolio while helping you implement diversification strategies to limit your downside potential now and in the future.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for asset allocation and diversification strategies.
As a corporate executive, you have unique asset allocation and diversification needs. To ensure you’re employing the most effective strategies, speak with a Carpenter Team expert during a complimentary consultation.
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