| Asset allocation refers to how much money you | | | | invest in a mix of growth and value stocks are |
| have invested in each of the major asset classes | | | | called blend funds. |
| such as stocks, bonds and cash. Studies have | | | | Sector refers to the specific industry a company |
| shown that asset allocation is one of the most | | | | is in or a fund invests in. Examples are energy, |
| important investment decisions an investor can | | | | financial services, utilities, health care, technology. |
| make, accounting for as much as 90% of return. | | | | Geographic location refers to investing in |
| Asset allocation is the process of determining the | | | | companies from a certain part of the world. Many |
| percentage of your investment portfolio that | | | | funds are just focused on the US while others |
| each asset class should occupy, based on your | | | | may focus on only foreign stocks or just stocks |
| risk tolerance. | | | | from a particular region such as Latin America, |
| Each asset class provides you with a different | | | | Asia, China, etc. |
| level of risk and different levels of potential return. | | | | If we put these different types of assets on a |
| Owning just one asset class, such as stocks, | | | | risk continuum it would look as follows with the |
| would be risky because the value of your entire | | | | highest risk first and the lowest risk last: |
| portfolio would depend entirely on the | | | | Commodities, Small cap stock, Foreign stocks, |
| performance of that asset class. The overall | | | | High yield bonds, Mid cap stocks, Large cap |
| purpose of asset allocation is to reduce volatility | | | | stocks, Real Estate Investment Trusts (REIT), |
| so that thriving investments in one asset class | | | | Intermediate term bonds, Short term bonds. |
| potentially outweigh losing investments in other | | | | So now if you put everything together that we |
| asset classes. | | | | have learned about asset allocation and |
| To determine your asset allocation you first need | | | | diversification we can come up with a portfolio |
| to determine your risk tolerance. Two important | | | | that has both asset allocation and diversification |
| factors that affect your risk tolerance are your | | | | for the greatest potential growth while limiting risk |
| time horizon and your personal response to risk. | | | | to a level that suits your financial situation and |
| Your time horizon is the amount of time you | | | | personality. The first number is for conservative, |
| have before you will need the money you are | | | | the second for moderate and the last number for |
| investing. In general, if you have a long time | | | | aggressive. Large cap stock 10%, 40%, 35% Mid |
| horizon (10+ years) you can invest with a higher | | | | cap stock 15%, 10%, 17% Small cap stock 7%, |
| risk tolerance (aggressive). A moderate time | | | | 3%, 17% Foreign stocks 14%, 25%, 22% Bonds |
| horizon (5 - 10 years) can tolerate moderate risk | | | | 43%, 22%, 9%, Cash equivalents 11%, 0%, 0%. |
| and short time horizons (1 - 5 years) should use a | | | | Again, there are many, many asset allocation |
| low (conservative) risk tolerance. However, the | | | | models out there and this is just an example of |
| second factor, your personal response to risk, | | | | how it works. As before, the percent in stocks |
| must also be taken under consideration. If you | | | | grows as you move from conservative to |
| avoid risk in everyday life or worry easily, you | | | | aggressive and the percent in bonds moves in the |
| need to be more conservative. You don't want to | | | | opposite direction. |
| get ulcers or lay awake at night worrying about | | | | Below is an example of how you could have |
| your aggressive investments even if you have a | | | | asset allocation and diversification with just seven |
| long time horizon. If you enjoy risk and don't | | | | funds. The first number is for if you are are to |
| worry easily, then you may want to lean toward | | | | mid career, the second number for late career |
| the aggressive allocation, if you time horizon | | | | and the last number for in retirement. Blue Chip |
| allows it. | | | | US Stock Fund FSMKX Fidelity Spartan 500 Index |
| A very basic model for asset allocation is as | | | | 40%, 30%, 20%. Blue Chip Foreign Stock Fund |
| follows with the first number in stocks, the | | | | VGTSX Vanguard Total International 30%, 25%, |
| second in bonds and the last number in cash | | | | 15%. Small Company Fund PRNHX T. Rowe Price |
| equivalents: Conservative 10%, 20%, 70% | | | | New Horizons 5%, 2.5%, 2.5%. Value Fund |
| Moderate 50%, 20%, 30% Aggressive 75%, | | | | VIVAX Vanguard Value Index 5%, 2.5%, 2.5%. |
| 15%, 10%. | | | | High Quality Bond Fund VBMFX Vanguard Total |
| There are many, many asset allocation models | | | | Bond Market Index 10%, 20%, 30%. |
| out there but they all follow the basic premise of | | | | Inflation-Protected Bond Fund VIPSX Vanguard |
| having a higher percentage in stocks (or stock | | | | Inflation Prot Sec 5%, 10%, 10%. Money-Market |
| mutual funds) as you move from conservative to | | | | Fund FDRXX Fidelity Cash Reserves 5%, 10%, |
| aggressive with the bonds/cash moving in the | | | | 20%. |
| opposite direction. | | | | is an excellent resource to use for studying your |
| Don't overestimate your tolerance for risk in good | | | | portfolio. Morningstar developed the equity style |
| times. If you are invested too aggressively when | | | | box where they put the diversification info in a |
| the market is rising, you are more likely to | | | | square box with nine boxes for a graphical |
| abandon your investment program when the | | | | representation of where the market cap and |
| market is falling. The most ideal asset allocation is | | | | investing style falls large to mid to small down the |
| that mix of assets that you can stick with in | | | | side and value, blend, growth across the top. |
| good times and in bad. | | | | If you aren't interested in trying to figure out |
| You also need to diversify within the major asset | | | | which funds to purchase and aren't interested in |
| classes. As an extreme example, a portfolio with | | | | rebalancing your portfolio once a year, you may |
| one stock, one bond and cash could have proper | | | | be better off putting all of your investments into |
| asset allocation but is not diversified at all. Most | | | | a target-date fund. These funds invest based on |
| investors should invest no more than 5% in an | | | | the time horizon you have and re-adjust as you |
| individual stock or bond. | | | | get older and you get closer to retirement. The |
| Diversification refers to owning various | | | | funds have a year in their name, such as 2025, |
| investments within each asset class. Don't own all | | | | 2030, 2035, etc. Pick the fund with the year |
| or your stocks or mutual funds in one industry | | | | closest to the year you plan to retire. |
| (such as technology). Don't own all municipal bonds | | | | You do have control over the quality of the |
| or municipal bond funds. Stocks and stock funds | | | | investments you own, the diversification of your |
| (also called equities or equity funds) are divided by | | | | portfolio and how long you hold your investments. |
| their market capitalization, their investment style, | | | | Right now, many investors are discouraged, some |
| sector and geographic location. | | | | are angry or upset, and others are just plain |
| Market capitalization (market cap) is equal to the | | | | confused. The best way to survive any crisis is to |
| number of shares the company has issued to the | | | | have a well-thought-out strategy and not let |
| public multiplied by the value of a single share. So | | | | emotions drive your investment decisions. Time is |
| the terms large cap, mid cap and small cap | | | | your greatest friend. Emotions are your greatest |
| basically refer to large companies, mid size | | | | enemy. Focus on the things you can control. Base |
| companies and small companies. | | | | your investment decisions on investment |
| Investment style refers to whether a mutual | | | | principles, not predictions. The three most |
| fund invests in growth stocks or value stocks or | | | | important investment principles are focusing on |
| a "blend" of both. Growth funds invest in | | | | quality investments, diversifying your portfolio and |
| companies that are rapidly growing businesses. | | | | holding your investments for the long term. Don't |
| Value funds invest in companies of established, | | | | abandon those principles. |
| slower-growing businesses. Those funds that | | | | |