Asset allocation
A strategy for reducing risk
The expression about not putting all your eggs in one basket also applies to your
investments. If the basket falls, all the eggs will break. It sounds like a simple enough idea: Don't put all of your money
in a single investment. Spread your assets around. Allocate assets into different types of securities.
The basics
Broadly speaking,
there are three different types of financial assets:
Setting up your asset allocation strategy
Given the risks and rewards of these different asset classes, determining the right mix for you depends on a number
of factors. First and foremost, you need to ask yourself:
1. What is my investment goal?
2. What is my time horizon?
3. How much risk am I comfortable with?
The answers, of course, are as individual as you are. But after you have identified them, everything else can fall
into place.
Defining your objective
What
are you saving your money for? A child's college education? Your own retirement? Maybe you're buying your dream house. Whatever
the answer, defining your goal will help you pinpoint your investment horizon.
Set attainable goals. Deciding you want to retire at 35 may be a pleasant diversion, but you've got to be realistic
or you may make rash decisions that involve more risk than is appropriate for your situation. You may feel brave or lucky,
but experts suggest placing only a portion of a portfolio in potentially high-risk opportunities.
Calculating your time horizon
Your time horizon is based on when you need the money.
If you're investing for retirement, you have the time until you retire and beyond. Remember to include
the number of years beyond your actual retirement date you'll need to draw on these funds.
Risk tolerance
The longer
your time horizon, the better you can weather the market's ups and downs and the more aggressively you can allocate your investments.
The shorter your time horizon, the more conservative you should be because your portfolio will have less time to recover from
market downturns. In other words, your risk tolerance changes with time. Your asset allocation should, too. Of course, your
investment personality has a lot to do with risk tolerance as well.
Remember: There is risk in being too aggressive as well as in being too conservative. Talk to your financial advisor about which choices should be on your list and keep
track of your investments' progress.
