Understanding Diversification
When you created your investment strategy, your asset allocation reflected your goals, time horizon, and tolerance for risk. Over time, however, any of these three factors may have changed, and your portfolio may need adjustments to reflect your new investing priorities.
Diversification
The saying “don’t put all your eggs in one basket” has some application to investing. Over time, certain asset classes may perform better than others. If your assets are mostly held in one kind of investment, you could find yourself under a bit of pressure if that asset class experiences volatility. Though many hot investments may seem alluring, not over-investing is key. Try not to own so much of something that you make a killing in a short time. Likewise, diversification helps prevent getting killed by one investment.
Keep in mind, however, that diversification is an approach to help manage investment risk. It does not eliminate the risk of loss if an investment sees a decline in price. In fact, the way assets interact with one another changes over time, and is worth revisiting this relationship.
Asset allocation strategies are also used in portfolio management. When financial professionals ask you questions about your goals, time horizon, and tolerance for risk, they are getting a better idea of what asset classes may be appropriate for your situation. However, like diversification, asset allocation is an approach to help manage investment risk. It does not eliminate the risk of loss if an investment sees a decline in price.
Determining an Appropriate Mix
Appropriate asset allocation is determined by each individual's situation. Here are three broad factors to consider:
Time: Investors with longer timeframes may be comfortable with investments that offer higher potential returns but also carry higher volatility or fluctuation. A longer timeframe may allow individuals to ride out the market’s ups and downs. An investor with a shorter timeframe may need to consider market volatility when evaluating various investment choices. With funds needed in the near term, you want to reduce the risk of having to sell when the price is down.
Goals: They come in all shapes and sizes, and some are long-term, while others have a shorter time horizon. Knowing your investing goals can help you keep on target. At the end of the day, a strong financial position is important as you can live life on your terms. Identifying those terms is your goal-setting process. It is the end game, and your investments are simply the medium to achieve those goals. When times get tough in the market and economy, it is important to measure up where you stand against your goals rather than an arbitrary benchmark.
Risk Tolerance: An investor with higher risk tolerance may be more willing to accept greater market volatility in the pursuit of potential returns. An investor with a lower risk tolerance may be willing to forgo some potential return in favor of investments that attempt to limit price swings.
Have Your Investing Priorities Changed?
If so, this is more reason to review and possibly adjust the investment mix in your portfolio. Asset allocation is a critical building block of investment portfolio creation. Having a strong knowledge of the concept may help you when considering which investments are appropriate for your long-term strategy.
This content is developed from sources believed to be providing accurate information and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.