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Achieving your financial goal for a comfortable and secure future doesn't hinge entirely on picking the right stock or mutual fund, but the method in which you divide or diversify your investments also has a significant impact on creating a WINNING portfolio. Proper diversification between stocks, bonds and cash, also known as Asset Allocation, is the foundation of sound investing. Asset allocation is based on the laws of Risk and Reward. Historically, stocks have performed the best over the long term, but are also the most volatile. Bonds, on the other hand, return less than stocks, but provide a more stable income.
Determining your investment profile is based on two main factors – your appetite for risk and your time horizon. Ask yourself these questions: Can I accept losing part of or even all of my capital? What is my time horizon – long term or short term? What do I need the money for? The answers to these questions will determine whether you are a:
- Conservative Investor
- Moderate Investor
- Aggressive Investor
Conservative Investor – If you can't stomach any risk or more importantly, your time horizon is very short – you are close to retirement or need the money to buy a house in three years, an appropriate mix would be 40% stocks, 40% bonds and 20% cash. If you prefer to remain very conservative, keep your stock portfolio in Blue Chip stocks and S & P 500 mutual funds.
Moderate Investor – If you have a long term investment horizon and can accept low to medium levels of risk, allocate your portfolio into 60% stocks, 30% bonds and 10% cash. If you can accept more risk split your stock portion between some conservative stocks or funds (Blue Chip stocks or Index Funds) and some more aggressive investment vehicles like a specialty technology fund or an aggressive growth fund. This should increase your return over the long run.
Aggressive Investor – Young investors in it for the long term and willing to ride out the hills and valleys of the stock market may establish an allocation model of 80% stocks, 15% bonds and 5% cash. If you are willing to "grab the bull by the horns and go for the gusto", consider investing in some high-flying stocks, aggressive growth mutual funds and specialty funds. Picking the appropriate aggressive stocks and mutual funds can increase your returns tremendously over the long term – remember time is on your side.
To maintain proper asset allocation, review your investment portfolio, including your IRA or 401(k) account, once a year or if you plan to invest more money periodically throughout the year make sure your new investment follows your allocation guidelines. Although we can't control the gyrations of the stock market, the right asset allocation will smooth the sometimes bumpy road to financial success.
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