From the course: Build Your Financial Literacy

Asset allocation

From the course: Build Your Financial Literacy

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Asset allocation

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- When you start to seriously consider investing, you'll probably hear about something called asset allocation. Simply put, asset allocation is an investment strategy aimed at balancing risk and reward. It allocates your assets according to you, your own beautiful individual goals, risk tolerance level, and timeline for when you wish to use your investment money. As a result, there's no single formula to find the right asset allocation mix for every need. For example, let's say you're saving to buy a new car in the next year. You may want to invest your savings into a very conservative mix of cash, certificates of deposits, CDs, and short-term bonds. This gives you a better chance protecting against inflation and growing your funds with minimal risk of losing your money. In a year's time, you'll then be able to cash out those investments and buy your new car. But what if you're saving for retirement that may be decades away? Well, generally speaking, for most of your investments, you'll want to participate in what we call age-based asset allocation, which determines the amount of stocks, bonds, cash, and money market amounts you'll invest in based on your timeline. In general, stocks are recommended for a holding period of five years or longer. Cash and money market accounts are appropriate if your goal is to use the funds in less than one year, and the use of bonds fall somewhere in between the one to five year timeline. When it comes to retirement, there's a rough, and I do mean a very rough, asset allocation formula. I say rough because there are many other factors that play into determining your asset allocation mix for retirement. However, if you're just starting out, you can refer to this formula. 100 minus your age equals the percentage of your portfolio, which should be invested in stocks. For example, 100 minus 40 years old equals 60% of your retirement portfolio should be invested in stocks. The remaining 40% should be invested in bonds, CDs, and more conservative investments to hedge against the market volatility of your stocks. As you get older, your asset allocation will shift more conservatively to protect your assets from volatility. For example, 100 minus 60 years old equals 40% of your retirement portfolio that should be invested in stocks. A simpler way to ensure that you're achieving appropriate asset allocation for your retirement is through life cycle funds, also known as target-date funds. These funds are automated through computer software calculations based on your age, risk appetite, and investment objectives, and will automatically shift to a more conservative mix as you reach your projected retirement year. So if you haven't already, think about whether you'd prefer to take on the asset allocation mix of your investments yourself, use an automated life cycle fund, or gain the expertise and guidance of a financial advisor.

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