Asset allocation is the process of dividing your investment portfolio among different kinds of investments, such as stocks, bonds, cash equivalents, real estate and other investments. This investment strategy helps to optimize investments and balance overall risk. This approach is used by many savvy investors.
Many financial professionals advise that asset allocation is one of the most important decisions an investor should make. In fact, they see the selection of securities as secondary when compared to the allocation. However, there is no standardized formula across the board to find the right asset allocation to meet the needs of everyone. Each investor must decide based upon their unique likes, dislikes, needs and goals.
The fundamental principals behind asset allocation are simple:
- Based upon historical performance, all classes of assets will periodically fluctuate up and down at the same time. In some years, stock in small companies yield the highest returns while in other years, stock in large companies have yielded the highest return.
- CDs and bonds have been just as strong as stocks in some years.
|
Years to Retirement
|
Investor Profile
|
Recommended allocation
|
|
20+
|
Highly Conservative
|
55% Stocks and Bonds
45% 10-year (or longer maturity) Treasury bonds
|
|
20+
|
Open to Risk. Seeking stronger returns.
|
80% Stocks and Bonds
20% 10-year (or longer maturity) Treasury bonds
|
|
10 or less
|
Open to Risk. Seeking stronger returns.
|
40% Stocks and Bonds
60% 10-year (or longer maturity) Treasury bonds
|
The general rule of thumb is that the younger you are, you may want to invest as much as 80 percent into a portfolio of stocks and bonds as they have historically yielded higher returns. As you grow older and are nearing retirement you will likely want to reduce the percentage you have invested in stocks and bonds in order to mitigate risk. In either case, you must understand what your specific goals are and determine the length of time you have to invest and your risk tolerance.