Asset Allocation
We will now turn our attention to Asset Allocation. All the different securities that you could possibly invest in are all collectively called assets or asset classes. As your savings increases, you will be purchasing more and more of these assets over time. So then the question becomes, exactly what asset classes are you going to purchase. A very general rule of thumb here is to subtract your age from 100 and the answer represents what percent you will devote (allocate) to stocks (equities). The balance would then be allocated to bonds. So if you were just starting out and you are 30 years old, you would allocate 70 percent of your portfolio to stocks and 30 percent to bonds. Very simply this would be your asset allocation. This 70-30 mix is not perfect though because usually you should leave a small percentage as cash to be able to take advantage of good opportunities that pop up from time to time. Maybe you want 5% in cash or 10% at most. Therefore the final mix would look like this: 65% stocks, 30% bonds, 5% cash. Or 60% stocks, 30% bonds, 10% cash. This is a form of asset allocation. You get the idea. So now you are thinking if historically speaking stocks have a better rate of return than bonds, why not just put everything into stocks? While that is a good question, the answer is also of a historic nature and that is as follows: Different asset classes perform differently in response to changing economic events and market factors. A simple example of this can be seen when stocks are falling, bonds tend to rise as investors see them as a safe haven and flee from stocks to bonds. Furthermore, purchasing different asset classes adds to the diversity of one's portfolio and as everyone knows, you don't want to put all your eggs in one basket. More advanced investors would be spreading their assets over a larger mix of asset classes. For instance, one could purchase commodities, futures, options etc. as a small percentage of their entire portfolio. Their Asset Allocation might look like this: 25% Domestic Equities (stocks), 25% Foreign Equities, 10% Corporate Bonds, 10% Government Bonds, 10% Municipal Bonds, 5% Commodities, 5% Precious Metals, and 10% Cash. Mutual FundsIf you are just starting out, there is a very good chance you should concentrate on mutual funds. Mutual funds are a basket of securities so one purchase in a particular fund gives you instant diversification and sometimes asset allocation. There are over 9000 different mutual funds. Some hold all stocks, some hold all bonds, some funds hold a mix of both stocks and bonds and some are very specific in what securities they hold in their portfolio. Maybe they don't have any stocks of companies that are involved in alcohol, firearms or tobacco as one example, or maybe they are concentrated on precious metals or other commodity. One other point to consider when deciding upon your diversification, just as different asset classes perform differently over time, foreign securities also perform differently versus American securities...the point is that you need to have some foreign exposure in your portfolio. You will see many financial articles dealing with the fact that China and India are the two fastest growing economies today. You should be able to capture some of that growth with your selections.For many investors, mutual funds are all they ever purchase and that is O.K. Stocks tend to have big swings from day to day so if you were to own individual stocks, you would probably see big changes both up and down in the value of your portfolio. On the other hand, holding mutual funds tends to smooth out the bumps on the investment highway. Furthermore, most companies that offer a retirement plan in the way of a 401(k) plan or a 403(b) plan, only offer mutual funds from which you have a choice to pick from once your account is funded. By the way, the name 401(k) or 403(b) is named as such because it references the section in the I.R.S. Code book that allows for these tax deferred savings vehicles. What that means is you can put some of your earnings into one of these plans BEFORE tax is computed on your pay. You then pay taxes on the remainder which since it is a smaller number means you pay less taxes. Your contribution therefore grows tax deferred until you retire and start to take a distribution from the account. At that point you are taxed on your distribution at your tax rate when you retire which for many people is a lower tax rate than when they are working so the end result is that you pay less taxes hopefully. I hope I have answered any questions you have on Asset Allocation. If you did not find what you are looking for, you might try Google Search! Go to Investment Guide from Asset Allocation
|
