Asset allocation 101

Author: Steven posted in Asset allocation tagged with asset allocation, Investing 101

Choosing the asset allocation for your investment program is probably THE most important decision you will make. Even more important than the individual stocks, ETFs, mutual funds or bonds that you will select.

Asset allocation explained

Asset allocation is an investment strategy to balance risk and reward. It is the process of dividing and distributing the assets of a portfolio among different investment classes in order to reduce the overall risk exposure. The three most common asset categories are stocks, bonds and cash and cash equivalents.

What is the best asset allocation strategy

There is no right or wrong asset allocation model as such decision is based on the investment objective, time horizon and risk tolerance of the individual. For example, if you are a long-term investor and have a high tolerance for risk then your portfolio will probably have a large percentage of stocks compared to bonds and cash. On the other hand, if you are risk averse and need money for a short-term project such as the purchase of a car, then probably cash and cash equivalents will have a greater weight.

The power of diversification

You are probably familiar with the saying” don’t put all your eggs in one basket”. This is exactly what investors are doing by spreading money among the different investment classes. Since each asset categories (stocks, bonds and cash) reacts differently to market conditions, by spreading your investment capital you are reducing the overall risk of your portfolio. If the return on investment on one asset category falls, you can offset the potential loss by having money invested in another asset category.

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