Basics Of Asset Allocation!

Your asset allocation strategy represents your personal decisions about how much of your portfolio to allocate to various investment categories, such as stocks, bonds, and short-term investments. Several concepts are important when considering your asset allocation strategy:

• While each type of investment tends to increase in value over time, each is also subject to declines over the short term. Asset allocation is designed to help protect investors from this volatility. Various investments are affected differently by economic events and market factors. Some asset classes move in opposite directions while others move in the same direction at varying speeds. By owning different asset types, it is hoped that when one asset suffers a major decline, other assets will be increasing in value.
• Market timing is a difficult strategy to implement, even for professionals. With an asset allocation policy, you don't have to worry about timing the market, you just have to make sure your investments stay within the proper percentages.
• Investments with higher return potential generally have higher risk and more volatility in year-to-year returns. While most investors desire higher returns, they may not be comfortable assuming higher risk levels. Asset allocation allows you to combine more aggressive investments with less aggressive ones. This combination can help reduce the overall risk in your investment portfolio.
• Staying focused on the proper allocation for your investments will help prevent you from investing in ones that won't help accomplish your goals.

Your asset allocation strategy will depend on a variety of factors unique to your situation. Four of the more important factors include:

1

 Risk tolerance. Carefully assess your tolerance for risk so you only invest in assetsyou are comfortable owning. If you take on too much risk, you may have difficulty carrying out the strategy. Your risk tolerance is likely to change over time, either as you become more familiar with investing or as you age. Familiarity with investing typically makes you more risk tolerant, while aging may make you more or less risk averse. Make sure to adjust your asset allocation as your risk tolerance shifts, so you don't become uncomfortable with the risk in your portfolio.

 

2

 Return expectations. To achieve your investment goals, you need to set realistic expectations about returns. While past performance is not a guarantee of future returns, reviewing historical rates of return can help you assess whether your return expectationsare reasonable. Keep in mind that higher returns generally are accompanied by higher risk.

 

3

 Time horizon. The longer your time horizon for investing, the more risk you can typically tolerate in your portfolio. Investing for long periods through different market cycles generally reduces the risk of receiving a lower return than you expected, especially with investments that can fluctuate significantly over the short term. Typically, young investors have longer time horizons than older investors, so they can invest more aggressively.

 

4

 Preferences regarding investments. With such a wide variety of investments to choose from, you should understand the basic aspects of each to decide which are appropriate for you. If you are not comfortable with a particular type of investment, you may want to exclude it from your portfolio.

All of these factors will help determine how you allocate your investment portfolio. In general, you should consider a more conservative allocation if you are older, have short-term needs for your money, have low earnings, have a low risk tolerance, or are uncomfortable with investing. A more aggressive allocation may be indicated if you have high earnings, are younger, do not need your money for many years, or are an experienced investor.

How much impact will your asset allocation have on your total return? That typically depends on how you invest. An investor who maintains a fixed mix of stocks and bonds that mirrors the overall market may find that asset allocation explains the majority of his or her return. However, an active investor who trades frequently, times the market, and changes allocations often may find that asset allocation has a much smaller impact on return.