- Asset allocation means spreading your investments across various asset classes. Broadly speaking, that means a mix of stocks, bonds, and cash or money market securities.
- Your ideal asset allocation is the mix of investments, from most aggressive to safest, that will earn the total return over time that you need.
- The mix includes stocks, bonds, and cash or money market securities.
- The percentage of your portfolio you devote to each depends on your time frame and your tolerance for risk.
- This isn’t a one-time decision. Revisit your choices from time to time to see if it is still meeting your needs and goals
- Equities have the highest potential return but also the highest risk. Treasury bills have the lowest risk because they are backed by the U.S. government, but they also provide the lowest return. This is the risk-return tradeoff. High-risk choices are better suited to investors who have higher risk tolerance.
- The rule of thumb is that an investor should gradually reduce risk exposure over the years, in order to reach retirement with a reasonable amount of money stashed in safe investments.
- As each asset class has its own level of return and risk, investors should consider their risk tolerance, investment objectives, time horizon, and available money to invest as the basis for their asset composition. All of this is important as investors look to create their optimal portfolio.
Maintaining Your Portfolio – As you decide how to allocate your portfolio, you might choose one of several basic allocation strategies. Each offers a different approach based on the investor’s time frame, goals, and risk tolerance. Once your portfolio is up and running, it’s important to conduct a periodic review. That includes a consideration of how your life and your financial needs have changed. Consider whether it’s time to change the weighting of your assets .Even if your priorities haven’t changed, you may find that your portfolio needs to be re-balanced. That is, if a moderately aggressive portfolio racked up a lot of gains from stocks recently, you might move some of that profit into safer money market investments.
The Bottom Line – Asset allocation is a fundamental investing principle that helps investors maximize profits while minimizing risk. The different asset allocation strategies described above cover a wide range of investment styles, accommodating varying risk tolerance, time frames, and goals. Once you’ve chosen an asset allocation strategy that’s right for you, remember to review your portfolio periodically to ensure that you’re maintaining your intended allocation and are still on track to your long-term investment goals