Some experts believe that asset allocation is the single most important factor in investment success.
Generally, you will want to consider a mix of stocks, bonds, and cash. The percentage you select for each investment category is the process of asset allocation.
For example, you may decide that your particular situation calls for a mix of 80 percent stocks, 15 percent bonds, and 5 percent cash. You might further break it down this way:
Short-Term Bond Fund 5%
These are hypothetical numbers for a hypothetical investor. You should base your particular allocation on a number of factors, including:
- Risk tolerance
- Years to retirement
- Your income
- Your savings
Investors often use the terms diversification and asset allocation interchangeably; however, asset allocation is a much more thoughtful process. Diversification means not investing solely in any one investment category. Asset allocation takes that one step further and assigns specific percentages to each category.
A general guideline is that younger investors can afford to be more aggressive because they have more time to ride out short-term drops in the market cycle. Older investors may be more comfortable with a conservative plan, particularly as they get closer to retirement. The more time you have, the better chance you have to reach your goals.
Things to Remember:
- Asset allocation is the process of splitting your investments among stocks, bonds, and cash.
- A properly balanced portfolio can help protect you from severe market fluctuations.
- Risk tolerance plays a big role in portfolio selection.
Things to Do
- Look at your portfolio at least once a quarter for proper balance more frequently in turbulent markets.
- Examine your current holdings and figure out the percentage you have invested in each category: stocks, bonds, and cash, and ask yourself if you are comfortable with that mix.