Recommended Portfolio Allocations

Allocate your money in a way that reduces risk.

Asset allocation is dividing your investment portfolio among different asset categories. To optimize the allocation, pay attention to your time horizon and your risk tolerance. The time horizon is the expected number of months or years you will invest in order to achieve your financial goals. Risk tolerance is your ability and willingness to lose some or all of your money chasing higher returns.

Investment Choices

Three broad categories of assets exist. The first is stocks, which, historically, have the greatest risk and highest returns. The second is bonds, which are less risky but produce more modest returns. The third is cash and cash equivalents, which are the safest assets but offer lower returns. Examples of cash equivalents include certificates of deposit, money market funds and savings deposits.

Asset Allocation

Historically, the returns of the three major asset classes have not moved up and down at the same time. By investing in more than one category, you can counteract losses in one category with another. Asset allocation allows you to pick a mix of assets with the highest probability of meeting your financial goals, with a risk level that you can live with. For example, a 30 year old investing for retirement might invest in more stocks with a higher risk due to the long time horizon, but a family investing for a teen's college fund might wish to concentrate on cash equivalents.

Diversitifcation

Diversification is the practice of spreading investments among different asset categories to limit fluctuations in returns. Spreading your money among various investments allows you to not put all your eggs in one basket, so to speak. Diversification is important among asset categories and within asset categories.

Rebalancing

A portfolio may become unbalanced due to the fact that some investments will grow more quickly than others. You have three basic ways to rebalance your portfolio to the original asset allocation. The first is to sell investments in the overweighted asset category and use the proceeds to purchase investments in the underweighted category. The second is to purchase investments in the underweighted category. Finally, if you are making continuous contributions to your portfolio, you may alter the contributions, so more is made to the underweighted category.

References

• CNN Money: Ultimate Guide to Retirement
• U.S. Securities and Exchange Commission: Beginner's Guide to Asset Allocation, Diversification and Rebalancing
• The Motley Fool: Retirement Asset Allocation

Resources

• Forbes: Asset Allocation Calculator
• American Association of Individual Investors: Asset Allocation Models