Asset Allocation
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Finding the mix that’s right for you.
Once you’ve identified your goals, time horizon(s) and risk tolerance, it’s time to actually start investing.
The first and most important step is to determine an appropriate asset allocation — how you divide your
investment money across the asset classes of stocks, bonds and CDs, and cash equivalents to meet your various
investment goals.
Studies have shown that the asset mix you choose, more than your actual investment choices, is the biggest
determinant of investing success. That’s because different asset classes respond to changing market
conditions in different ways and degrees. By having a mix of investments, you can increase your portfolio’s
overall potential for gain and decrease the effects of risk.
This means that for protection, you don’t want to have all your investments in one place, particularly in
aggressive or volatile investments. However, to get the returns you need, you can’t afford to put all your
money in ultra safe, low return investments.
So how do you choose?
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Understand the choices.
The three primary asset classes and their characteristics are:
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Equities — including stocks and stock mutual funds— generally have the highest long-term return potential
along with the highest risk and volatility. (See Stocks.)
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Fixed income investments — bonds, bond mutual funds and CDs — represent a very broad spectrum of risk and
return characteristics. Some long-term or high yield bonds/bond mutual funds may entail significant risk
in pursuit of higher returns; some very short-term, high-quality bonds/bond mutual funds may be almost
as safe as money market funds. CDs offer a unique combination of safety and high returns. (See
Bonds and CDs.)
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Cash equivalents — money market funds and savings accounts — emphasize protection of your money with
easy access and typically without fees. They pay interest rates. (See
Money Market Funds and
Savings Accounts.)
Match your goals with appropriate asset types.
Put your goals into categories based on their time frames: short, medium and long. To meet long-term goals,
most experts agree that you need stock investments within your general asset mix. Over time, equities have
delivered the highest returns, handily beating other types of investments and outpacing inflation. And with
a longer time horizon, you can simply ride out periods of volatility in the stock market.
If you’re close to retirement or you’re already retired, safety may be your priority. With the innovative
new CDs available today, you can earn high yields with no risk.
The bottom line for everyone is to find a mix that suits you — with a level of risk you can tolerate and
overall returns that bring you steadily toward your goals.