When it comes to investing, we all hear these words: “Make sure you are well diversified… Make sure your assets are properly allocated … Don’t put all your eggs in one basket…”
Asset allocation and diversification work hand in hand. Very simply put, asset allocation means your investments are spread across different asset classes, such as stocks, bonds, and cash equivalents. Diversification is having different investments within those broad asset classes.
For example, an investment portfolio, such as a 401(k), may have 60% stocks, 30% bonds, and 10% cash equivalents. Within those three broad asset classes, the portfolio could contain large-cap, small-cap, international, real estate, metals and specialty stocks; U.S. corporate, international and municipal bonds; and CDs or government T-bills. Please note, these are not the only options...there are many! And the combination that is right for you would depend on several factors including, but not limited to, your time horizon (for most people, this is years until retirement), risk tolerance, and current and future financial goals.
You may be asking yourself: “How do I know what is right for me?” This is where it’s important for you to at least talk with the advisor that manages your company retirement plan. He or she can help you design a comprehensive plan that looks at your entire financial and personal picture to create a financial roadmap that makes the most appropriate allocations for your individual needs. If your company’s retirement plan advisor cannot help you with this, seek out a financial advisor who can.
The asset allocation, or different combination of investments specific to you, helps to maximize your potential gain and minimize the overall risk of losing money. The factors in the economy and market that cause one category of assets to perform well could simultaneously cause another category to perform poorly. For example: In a time of market crisis, large-cap stock value could decrease in general, while U.S. Treasury security value could increase because people may want a vehicle of higher quality that’s backed by the U.S. Government for more stability.
Even though proper asset allocation is not a guarantee against loss, it is an effective strategy to manage investment risk. About 91% of a portfolio’s overall performance depends on proper asset allocation. Market timing, security selection, luck, and other factors make up a relatively small percentage of performance.
When is the last time you looked carefully at your company retirement plan or that old 401(k) that’s sitting around from a former employer? If you’re like the majority of the working class, chances are your specific mix of investments may be out of balance. They may no longer match your goals or fall within your risk tolerance. As investments increase and decrease in value and your returns are reinvested to buy more shares in your portfolio, the asset categories can change in proportion to each other. Therefore, it is important to review your investment portfolio, objectives, and options at least once a year to keep your assets balanced and help increase the probability that your retirement savings will meet your retirement goals.
Diane Sague Ehnes is a Financial Advisor with Waddell & Reed. She lives in Southeast Portland with her husband and two young sons. Diane can be reached at dsehnes@wradvisors.com or 503-238-6036 x203. Waddell & Reed, Member SIPC.
The opinions expressed are those of Diane Sague Ehnes and are meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. Please consult your financial advisor prior to making financial decisions.