Asset allocation and diversified investments are two buzz words often used in the investment community. The goal today is to help understand what they mean.
What is Asset Allocation?
Asset allocation is deciding what percentage of your money you want divided into various buckets, mainly stocks, bonds and cash. How you decide to allocate your money into these different options should be defined by:
- Your risk tolerance
- Time horizon
- Various other factors
Generally speaking, if you are a risky investor you will have more of your money invested in stocks. History shows us that stocks have a greater likelihood of earning money over the long run. Stocks also have a greater chance of losing money.
If you are a conservative investor, you will likely be more comfortable with bonds or cash. Bonds and cash historically earn less. So why would you ever choose to earn less? Primarily because you aren’t comfortable with the inherent ups and downs of stocks. There is good news for bonds too. The good news is bonds typically have less volatility (a.k.a. they are unexciting). The ups aren’t as high, but the lows aren’t as low.
Keep in mind all bonds are not created equal. Depending on the type of bond you purchase, you may be exposed to credit risk, prepayment risk, default risk, and interest rate risk.
What Should My Asset Allocation Be?
This is the million dollar question! The decision on how you allocate your assets is a critical one. Your initial asset allocation will be dictated by a number of considerations. The goal is to balance your return expectations (how much you want to make) with your appetite for risk (how much you are willing to lose).
The lower risk, high return mythical unicorn we all seek doesn’t exist (if you think you’ve found it, I am assuming your friend Big Foot told you about it while visiting the leprechaun at the end of the rainbow. Sarcasm my friends, sarcasm). Keep in mind your allocation can change as your financial situation changes. Some things to consider are the following:
- If and when you need the money
- What type of money is it (IRA, ROTH IRA, 401K, taxable, etc.)
- Do you have other assets in addition to these assets
- Your age
What are Diversified Investments?
Assuming you have already decided on an appropriate allocation as discussed above, the next step is to pick investments to help fill you need. The goal should be to invest in a number of similar but different strategies.
When looking at stocks, you can:
- Diversify into large, medium, or small cap stocks (or stock funds)
- Choose growth or value stocks
- Decide if including international stocks makes sense for your portfolio
- Look into emerging market stocks and weigh the potential versus risk for your comfort zone
Bonds have all different types too. You can be invested in short term or long term bonds (or bond funds). You can include corporate, municipal, or government bonds, bonds with high quality, or high yield. A good diversification strategy should allow your money to be invested in stocks and bonds with multiple objectives and expectations.
Whether you opt for asset allocation or diversified investments, at the end of the day both options employ to help protect against risk as you invest. Figuring out which option is right for you comes down to what you prefer and what your long-term goals are.
At the Greater West Chester Chamber of Commerce, we focus on helping our members attain new customers, address their most serious business challenges and become an integral part of our thriving community. Sign up today and connect with like-minded individuals that can help you make an informed decision on which investment route to take!