Why Asset Allocation Is Important
Be sure to also read the 7 Questions to Ask When Buying a Mutual Fund.
Defining Your Own Asset Allocation
Conservative Portfolio: The goal is to protect the principal value. A conservative portfolio is for those investors with a short time horizon, and a low level of risk tolerance. Ideal for people in retirement or close to retiring.
- 70%-75% Fixed Income Securities
- 15%-20% Equities
- 5%-15% Cash and Equivalents
Moderately Conservative Portfolio: To protect the principal value while adding a bit more risk. For those investors with a short time horizon and a low level of risk tolerance.
- 55%-60% Fixed Income Securities
- 35%-40% Equities
- 5%-10% Cash and Equivalents
Moderately Aggressive Portfolio: Also known as “Balanced Portfolios,” these are equally split between equities and fixed income. Great for investors with a medium risk tolerance and a time horizon longer than five years.
• 35%-40% Fixed Income Securities
• 50%-55% Equities
• 5%-10% Cash and Equivalents
Aggressive Portfolio: Mainly consist of equities to achieve long-term growth of capital. Meant for those with a high-risk tolerance and long time horizon.
- 20%-25% Fixed Income Securities
- 65%-70% Equities
- 5%-10% Cash and Equivalents
Very Aggressive Portfolio: The main goal is aggressive capital growth over a long time horizon. This asset allocation would be for those with a high-risk tolerance and a long time horizon such as young adults.
- 0%-10% Fixed Income Securities
- 80%-100% Equities
- 0%-10% Cash and Equivalents
Be sure to read about the 10 Biggest Mutual Fund Investing Myths Debunked.
Types of Assets
Historically, stocks have had the greatest risk but also the greatest returns among the asset classes. In the short run, stocks can be very volatile, and during recessions take the biggest hit, as seen during the Great Recession when the Dow dropped 54% hitting 6,547 in March 2008. However, when held over the long term, with the benefits of diversification, stocks have outperformed every other asset class. Within stocks there are subclasses such as large-cap stocks, small-cap, international and emerging markets.
Bonds are generally less risky than stocks, and less volatile, but their returns are also smaller. Typically, as an investor gets older, his or her portfolio might be geared towards having a heavier focus on bonds rather than stocks to reduce the risk of the portfolio. Within bonds there are also junk bonds, or high-yield bonds, that give higher returns, but are also riskier.
This includes holding cash or cash equivalents such as savings deposits, Treasury bills, and money market funds. This offers the lowest returns of any of the asset classes, but also has the lowest risk with only inflation to take into consideration.
The benefits of real estate include building equity and price appreciation, along with being an inflation hedge; rents received from tenants tend to rise with inflation. Further, if it’s a principal residence, any capital gains are tax-free. As an alternative to owning the hard asset, investors may also be attracted to investing in real estate investment trusts (REITs), which are exchange traded investment vehicles that give exposure to real estate with the ease and convenience of buying and selling on a stock exchange.
Commodities along with real estate are “real assets” unlike stocks and bonds that are “financial assets.” Commodities therefore act differently than stocks or bonds and are a lot more volatile. They can be a good asset class for diversification and act as an inflation hedge, but investors should be prepared for wild swings dependent on supply and demand of the given commodity.
Managing Your Asset Allocation
The Bottom Line
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