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With something as important as your future, how you invest your savings is not something to leave to chance. It should be part of a deliberate strategy designed to maximize your returns and minimize your risk of loss. Most experts agree the younger you are, the more aggressive and risky your investments should be, to take advantage of higher returns over the long term. In some cases, this may not be the best strategy, depending on the intended use for your savings.
Asset allocation by age is often used by people planning for retirement with accounts such as 401(k)s. The theory behind age-based asset allocation is that a younger investor has more time to recover from losses and take advantage of potential gains, making stock market investing more beneficial. As you age, you invest more in less-volatile investments such as bonds, possibly even switching to ultra-safe investments like certificates of deposit as you reach retirement. Even at retirement, some of your nest egg may not be used for many years, so stocks still could make sense for a portion of your funds.
You can adjust your asset allocation for long-term investing depending upon your goals. For example, if you are saving for your children's college expenses, you typically would want your money invested in stocks, more aggressively when your child is younger. As your child nears college age, you would want to invest more conservatively, choosing bonds or other fixed-rate options, to reduce the risk of the sudden loss of your investment.
By Risk Tolerance
For some investors, the biggest factor in their long-term investing asset allocation is how much risk they can accept. You may be an investor who cannot accept your investments losing value, even if they are likely to gain the loss back in the relatively short term. In this case, you might choose a relatively conservative investment strategy, investing in bonds, money market mutual funds or bank certificates of deposit. While these investments have less or no risk of loss of principal, they carry a significant risk that your money will lose significant spending power over the long-term because of inflation.
Allocated Mutual Funds
Mutual fund companies have created funds that take advantage of basic strategies for long-term asset allocation. These funds have a target date, which is when the investor expects to need the money. The year the investor reaches retirement age would be a potential date, or the year a child will begin attending college. These fund managers choose investments based on how much time remains until the selected year, with the portfolio becoming less aggressive over time.
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