Asset Allocation 101

by Guest on February 1, 2012

One of the biggest mistakes inexperienced investors make is to throw all their capital into one well-performing stock in the hopes they’ll see extraordinary returns in a short time.  While this can and does happen occasionally, it is mostly blind luck, and altogether not a very wise investment strategy.

A more seasoned investor will tell you that the best way to play your money is to diversify your assets.  And that, almost all the time, is the best advice you can get.

There are a lot of factors that make up a sound retirement investment strategy, but one of the most important ones is asset allocation, or where you put your money.  Your portfolio shouldn’t me made up of entirely one kind of investment; rather, it should include a variety of asset classes.

Assets can be most basically classified as either:

Stocks

Bonds, or

Cash

However, these categories can be further classified into sub-categories, as the following table shows.

Stocks

Bonds

Cash

Small Cap Long Term Money Markets
Large Cap Intermediate Term
International Short Term
Emerging Markets High Yield

Essentially, the goal of having a portfolio made up of several different kinds of classes is to minimize the volatility of your portfolio’s performance over time.  When you invest in multiple asset classes, your overall portfolio won’t be so dramatically affected if one of them is performing poorly, whereas if you put all your eggs in one basket, so to speak, the strength of your portfolio will be determined solely by the performance of one stock or bond.

Granted, diversifying your portfolio doesn’t guarantee that your portfolio will perform or that you will be protected from loss.  You still run a risk, but it’s generally a lower risk than investing in only one kind of asset class.

How to Find Your Mix

To find the right balance of assets for your portfolio, there are two variables you should consider:

1.   Risk toleranceHow much risk are you comfortable with?  The answer to this question will determine what asset classes you can emphasize in your portfolio.  Stock in small companies, high yield bonds, and international stocks, for example, all have great potential for return but are also less predictable, and have a higher probability of plummeting.

2.   Time horizonHow long do you have until you plan to retire? Typically, if you are very close to retiring (within 5-10 years) then you should minimize the volatility of your portfolio.  It’s better to get steady, slow gains, rather than risk everything to get a few slightly higher gains.

There is much more to learn about asset allocation, but this is a good place to start.  Just remember: investment is an endurance game, so picking the flashy stocks that seem to be performing well and investing everything in those probably won’t yield the results you want.  Slow and steady wins the race!

About The Author

This guest post is contributed by Angelita Williams, who writes on the topic of online courses.

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