Asset allocation might be called “planned diversification”. It is a strategy for keeping all your eggs from being in the same basket; the process of spreading your money between different types of investments to make it more productive, efficient and consistent with your life plans and risk tolerance.
There are a number of ways to approach asset allocation; you might first evaluate your current asset allocation by looking at the general categories of assets you own.
If you are a home owner, your home is an asset. If you are a business owner, your business is an asset. Your 401k, IRA and mutual funds are assets too. Technically your car, TV and cell phone are assets, but for the purpose of this article we will be discussing investment assets – those that have a reasonable chance of providing income or increasing in value over time.
Financial planners usually focus on traditional asset classes like stocks and bonds or mutual funds made up of stocks and bonds, but it is important for a planner to know about your other assets as well to consider them in the process.
Depending on your risk tolerance and investment objectives, you may or may not want to be over-weighted in one particular asset category or class. Within each of these categories, asset allocation and diversification play an important role.
In your stock investments, because of the unpredictable nature of the markets and the varying reactions of different asset classes, it’s good to have a combination of small-, mid- and large-cap stocks as well as a blend of companies with growth and value orientations.
You’ll also want to take a look at sectors – do you have too many companies that are involved in the technology sector? Healthcare? Consumer related stocks? Each sector carries its own risks -or upside potential- in reaction to new innovation, government mandates, or economic downturns, for example.
Diversification in bonds is usually measured by maturity dates, quality ratings, and by type of issuer.
How do I know what allocation is right for me?
You and your financial planner should talk through your goals, investment experience, risk tolerance, and your time frame before beginning the process of allocating investments. There are sample portfolios on various web sites that can give you example allocations for various life stages; these are a great starting place. You may not adhere to their recommendations, but will learn a lot about your portfolio as you compare and contrast how you are positioned compared to a generic portfolio allocation. The better you know your portfolio the better investor you’ll be.
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