How to Make an Investment Portfolio More Conservative With Asset Allocation
Asset allocation divides investment portfolios into several asset classes, such as stocks, bonds, mutual funds and cash. The percentage of each asset class in the portfolio depends on the financial planning horizon and risk tolerance of the investor. The safest form of investment is cash or cash equivalents, such as U.S. Treasury bills, certificates of deposit and savings accounts. Stocks are usually the riskiest form of investment. However, there is a tradeoff because stock returns tend to outperform cash and bond returns over the long term.
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Instructions
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Diversify your portfolio, which means invest in different asset classes and in different securities within each asset class. Diversification lowers the volatility of your portfolio because a sharp drop in one asset may be offset by increases in another. This also makes your portfolio conservative because if you only hold stocks, your portfolio returns might experience wild swings through the year.
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Design a balanced portfolio between stocks, bonds, mutual funds and cash. A conservative portfolio does not mean that you must hold only cash or bonds. Financial writer J.D. Roth of Get Rich Slowly suggests that you should not abandon stocks if you have a long-term investment horizon, which means that you do not need to draw down your investments in the near future.
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Decide on a portfolio mix. A conservative portfolio allocation could be 30 percent cash, 50 percent bonds and 20 percent stocks. This type of portfolio produces steady annual cash flows from interest income and dividend payments, and some capital appreciation from the equity component of the portfolio. For a more aggressive portfolio, increase the proportion of stocks in the mix.
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Select securities for the different asset categories in your portfolio. Stock picking involves reviewing financial statements and industry trends. If you do not have the time to do this research, consider investing in mutual funds and exchange-traded funds, which are professionally managed pools of money that offer diversification at low cost. The American Association of Investor Funds suggests an asset allocation of 50-50 between bonds and stocks for a conservative portfolio, and a further subdivision of small-cap, mid-cap and large-cap stocks within the stock component and intermediate and short-term bonds within the bond component of the portfolio.
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Rebalance your portfolio to return to the target asset allocation because financial market volatility may change the portfolio mix. For example, if a sharp increase in stock prices changes the stock portion of your portfolio from 20 to 30 percent, then sell stocks, buy bonds or do both to restore the stock component to 20 percent.
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