I was pondering my asset allocations the other day and noticed that I wasn’t fully accounting for all of my assets. I know, not the most exciting revelation, but it can have a profound impact on your finances.
See, when I was considering my asset allocation and risk tolerance I was only considering my investments. That was a problem I needed to fix quickly. Why?
Managing risk is a very important part of mastering your finances. If you’ve properly allocated your assets based on your risk tolerance, you’re much less likely to take a loss when investments turn south over the short term. But, first, what is an asset allocation exactly?
Asset allocation is the distribution of your assets across different types of investments. The concept behind asset allocation is spreading our your assets to match the amount of risk you’re willing to take to get a range of returns on your investments. Asset allocation is most commonly referred to when you’re dealing with paper investments, such as stocks, bonds and other paper asset classes.
How Asset Allocation Can Change How You Look At Your Finances Forever
If you tweak this definition just a bit, you can see your asset allocation based on all of the assets you own. This was exactly the exercise I needed to perform to make sure my assets matched my risk tolerance. The results may shock you and cause you to reconsider how you’re allocating your money.
How To See Your Total Asset Allocation
For the purposes of this exercise, you’ll need a list of all of your assets and their values. For any assets that you have loans on, you’ll also need how much you owe on them as well. List all of your assets you own free and clear. Next, for assets you owe someone money on, list the amount of equity you have in each asset (which is the asset value less the amount you owe against it).
Group like items, such as cars, real estate, cash, bonds, stocks, etc. Now figure out how much each class of assets is a percentage of your total assets. Are the results shocking?
What I Learned From This Exercise
I found out that my overall asset allocation is a lot more conservative than I had hoped for. I keep my paper investments at a ratio of about 90% stocks and 10% bonds. However, once you throw in the fact that we have cash, cars and real estate, our stocks and bonds are a much smaller amount of our total asset allocation.
After I gave it some thought, it did make sense that a large portion of my assets is the equity in my house and our rental townhouse. I just never realized that it would push our stocks and bonds down so far on our list.
It was a bit of a shock to realize that our cars were a meaningful chunk of our asset allocation, too. It was a bit depressing though since I know my cars will continue to lose value.
What You Can Take Away From This Exercise
If you were shocked to see that your cars were a huge part of your asset allocation, maybe you’ll decide to sell your car and buy a quality used car instead of the luxury SUV you currently drive. If you were amazed by how much cash you had as part of your asset allocation, maybe you’ll invest a bit more in stocks, bonds or real estate.
If real estate was too big for your comfort, maybe you’ll downsize your house or sell a rental property. Keep in mind your asset allocation should match your overall risk tolerance.
I want to hear about what shocked you most about your total asset allocation! Let me know in the comments down below!