Diversification Is Key To Asset Allocation

Tuesday, October 7, 2014, AM | 1 Comment

When you talk to a financial adviser, you must understand and be mindful of some strategies for asset allocation. Any strategy must consider short- and long-term goals in line with your current circumstances and your future potential earnings. Generally, among asset classes, stock may present more short-term risk and volatility than bonds but may provide greater potential return over the long run.

Risk with Bonds

Even though, with less risk than stocks in the short-term, bonds do have inherently risk properties that you should be aware of.

  • The risk of interest rate
    As interest rate rise, bond prices usually fall, the reverse is true as well.

  • The risk of default
    When a bond issuer is unable to make income or principal payments, the bond becomes high risk investment.

  • The risk of inflation
    Bonds and short-term investments entail greater inflation risk, or the risk that a return on investment will not keep up with increases in the prices of goods and services, than stock.

  • The risk of foreign investments
    Foreign investments, especially those in emerging markets, involve greater risk and, therefore, may offer greater potential return than U.S. investments.

Diversification Strategies

The six target asset mixes shown below are examples and are strictly for illustrative purposes.

You should choose your own target asset mix based on your particular age, risk tolerance, and financial situation. Be sure to review your portfolio periodically to make sure your investments are consistent with your goals.

Diversification Is Key To Asset Allocation

  1. Short-Term

    Short-term investment generally seeks to preserve your capital and can accept the lowest returns in exchange for price stability. This holds true when you are already retired or close to retire, among of course other times as well.

    • Cash: 100% of your capital
  2. Conservative

    This type of strategy seeks to minimize fluctuation in market values by taking an income-oriented approach with some potential for capital appreciation.

    • Bonds: 50%
    • Cash: 30%
    • Domestic stocks: 20%
  3. Balanced

    Balanced strategy seeks the potential for capital appreciation and some income and can withstand moderate fluctuation in market value.

    • Domestic stocks: 45%
    • Bonds: 40%
    • Cash: 10%
    • Foreign stocks: 5%
  4. Growth

    This type of investment seeks growth and can withstand significant fluctuation in market value.

    • Domestic stocks: 60%
    • Bonds: 25%
    • Foreign stocks: 10%
    • Cash: 5%
  5. Aggressive growth

    The investment is done for aggressive growth and can tolerate wide fluctuation in market value, especially over the short term.

    • Domestic stocks: 70%
    • Foreign stocks: 15%
    • Bonds: 15%
  6. Most Aggressive

    The investment is done for extremely aggressive growth and can tolerate very wide fluctuation in market value, especially over the short term.

    • Domestic stocks: 80%
    • Foreign stocks: 20%

In a Nutshell
You can be aggressive in your investment strategies when you are young. But closer to retirement, you should preserve your capital and go for short-term or very conservative strategy.

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