The topic of asset allocation has received more attention from investors over the last couple years. Regrettably, this idea usually garners more attention in difficult markets, but is often overlooked when times are good. To make the most of your investments, asset allocation is a philosophy that should be adhered to in both good times and bad. Sticking to this principle can help to ease your pain in times of a bear market, and it can also help you from getting carried away when times are good.
Once you have decided on a plan for your investments, implementing asset allocation involves combining asset classes in varying proportions. In general, investors who are more aggressive with their money will tend to have portfolios that are more heavily weighted in stocks. More conservative investors who still want the opportunity for growth in their portfolios will likely own some mix of stocks and bonds with a little cash set aside as well. For investors looking for stable income, a portfolio composed primarily of bonds may be appropriate, while investors who want to protect principal more than anything else may weight their portfolios more heavily with cash.
Just as individual investors vary greatly in their personal preferences, there are a myriad of possibilities when looking for an asset allocation to match each one. So, to implement this philosophy in your personal investing, let’s take a look at some of the asset classes you will choose from to make up your own portfolio.
Cash - In addition to the cash you probably have in your bank savings account, you may also own cash equivalents such as certificates of deposit, money market investments and government treasury bills. Knowing you won’t lose your cash to market fluctuations provides a certain sense of security. However, if you want your portfolio to have the opportunity to grow, or even if you just want to keep up with the cost of living, cash tends to be a less appropriate investment vehicle.
Bonds - By purchasing a bond, you are in effect lending your money to a company or a government entity for a specific purpose. The company or the entity, known as the "issuer," pays you interest in exchange for the loan represented by your bond purchase. While they usually have lower total returns than stocks, bonds tend to offer a stable income stream and generally have less volatility. Bond prices do fluctuate as interest rates rise and fall though. If you buy a bond and hold it until maturity, you won’t have to worry about price changes, but you should still be aware that the bond market is subject to fluctuations. If you sell your bond prior to maturity, you may receive more or less than the original investment.
Stocks - When you buy stocks, you literally own a portion of the company whose stock you buy. Therefore, any risks the company takes on are yours too. On the other hand, any rewards - meaning profit - may be paid to you in dividends or put back in the company to help it grow. While they do typically involve more risk than other types of investments, stocks have tended to provide a higher return than bonds or cash. But remember that past performance is no guarantee of what may happen in the future.
Given the amount of risk you’re willing to assume with your investments, and the amount of time you have to work with, asset allocation helps you establish goals for what you hope to accomplish and then divide your investment dollars among appropriate investment vehicles to reach those goals. The main thing allocation does for you is it keeps you grounded and provides a steady course to follow, despite the ups and downs that will invariably affect the market. If you would like to receive the A.G. Edwards’ publication, "Controlling Risk on Your Way to Retirement: An Asset Allocation Approach to Investing," please contact financial consultant, Shelley Phillips-Mills in Bangor at 1-800-9947-5456.
This article was provided by A.G. Edwards & Sons, Inc., Member SIPC.