Asset allocation may be the investment equivalent of flossing your teeth, most people know they should do it, but somehow they just don't get around to it.
Real asset allocation planning looks at the full scope of investments that includes stocks, bonds and money market instruments.
In many ways asset allocation is synonymous with diversification. But diversification is a relative term. While most investors will tell you they are diversified, they probably don't have a real asset allocation plan. Consider the co-worker who likes to brag about his/her portfolio of 20 pharmaceutical stocks. Are they really diversified? Probably not. The idea being that, whatever the market environment, some of these investments should be advancing, or at least holding steady while others are falling in value. An asset allocation portfolio may not provide the fireworks of a narrowly invested one, but it will hopefully also lessen the chance of disappointment.
The media often paints with a broad brush when it comes to the stock market.Stocks are either up or down & end of a story. Usually, however, it's just not that simple. During any given market environment, some stocks are usually rising while others are falling. Quite often trends emerge, and rising and falling stocks will fall into distinct asset classes. For example, small company stocks often perform well during times when large company stocks are languishing and vice versa. If you're serious about building a truly diversified asset allocation plan, you should consider the pros and cons of investing in the various major stock asset classes, including small cap and large cap, value and growth, plus foreign and U.S. To a certain degree, similar thinking also applies to different types of bonds.
If asset allocation is beginning to sound complicated, that's because it can be.
What's more, spreading your money among different asset classes is just half the challenge. That's because your asset allocation plan should obviously match your goals and the degree to which you are willing to accept investment risk.
Don't be fooled by advice suggesting your age dictates how your investments should be allocated. Asset allocation is not a one-size-fits-all process. So, before you start figuring out what percentage of your money should be in foreign-denominated bonds, you should probably call your investment professional. He or she should be familiar with the historical returns of various asset classes and know how closely the performance of one asset class correlates with another. A financial professional will also know which investments might be used in your plan to give you a greater degree of diversification and possibly professional management to boot.
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