When you invest, you can increase your chances of making money and avoiding losses by choosing different asset classes. In addition, you can choose a variety of investments in each class. The goal is to give yourself the chance to make profits without taking on more risk than you are comfortable with. Though "experts" may advise you on how to spread out your investments, you have to develop a personalized strategy that fits your needs.
An asset allocation strategy begins with spreading your investments among the three broad categories of stocks, bonds and cash, according to the Securities and Exchange Commission. Cash investments tend to be safer than stocks or bonds, so invest in this asset class for safety. Bonds can pay higher interest than cash investments, but carry some risk of losing their value. This type of investment is for that part of your portfolio from which you need income, with slightly more risk than cash. Stocks can be the riskiest of the three asset classes, but a winning stock can make more money than either bonds or cash. Your strategy should allocate money to each class according to your own tolerance for risk.
Diversifying Within Asset Classes
Within each asset class, you can find investments that offer different benefits. For example, some stocks can offer pure growth with no dividends, while other stocks pay a quarterly dividend and tend to grow more slowly. Bonds can include government issues and corporate securities. Government bonds are backed by the agency issuing the bonds, so they can be somewhat safer than corporate bonds. On they other hand, corporate bonds can offer a high rate of return for those who feel confident the corporation will be able to pay the interest on its bonds. Stocks include large corporations that offer stability, medium-sized companies that offer growth potential with a little stability, and small companies that can be risky but also may experience explosive growth. Cash investments can range from government-insured deposits such as CDs to money-market mutual funds that aren't insured.
Overall Portfolio Risk
If you focus on diversifying among various assets, you can lose sight of your portfolio as a single entity. Take the time to evaluate your entire portfolio's overall risk and potential gain. For example, if you have chosen individual investments that have high growth potential because you liked each one, a look at your portfolio may reveal that you have too much risk for your preferred level of security. Take a step back and examine your portfolio as a whole, so that you can see if you have too much risk or too little opportunity for profits.
You can't just let your portfolio sit after you have put your money into your chosen asset mix. The value of some assets rise while others fall, and you have to make sure you have the right amount in each asset class as time goes by. For example, if your stocks do well, you could have a much higher percentage of your total portfolio in that class. It could be time to sell some stocks to bring the percentage back in line. You could use the proceeds from the sale to buy an asset in another class. Rebalancing helps you keep the mix in the proportion you want.
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