That’s why diversification is so important.
Riskier investments like stocks provide the best returns over the long term; they also happen to be the most volatile asset. Bonds, on the other hand, are much safer, and, as a result, offer very little when it comes to returns. By combing different types of investment strategies among different asset classes, investors can generate profit and reduce risk levels to meet their retirement goals.
To help minimize the risk of human error, emotions, and uncontrollable outside factors and to maximize long-term performance, investors concentrate on asset allocation—the art of spreading out their money in stocks, bonds, commodities, cash, and, for some, real estate.
The old asset allocation equation used to suggest people keep a percentage of bonds equal to their age in their retirement fund, with the remainder in stocks; a 40-year-old, for example, would park 40% of their investments in bonds and 60% in stocks. But since no two people have the same financial needs, it’s pretty hard to have an asset allocation strategy that works for everyone. The fact of the matter is that it’s up to each individual to find an asset allocation risk level that meets their long-term portfolio needs.
That can be difficult to do in this climate. In spite of weak economic news and high unemployment, the S&P 500 and Dow Jones Industrial Average are hitting new highs. When it comes to asset allocation, it can be difficult to know where to start.
If retirement is still a number of years away, it’s a good idea to consider putting more money into the stock market. For starters, stocks keep pace with inflation and, hopefully, increase over time; on the other hand, the not so distant past shows us that stocks can crater during a recession. Still, with retirement on the distant horizon, your retirement fund has time to recover. And history has also taught us that the markets always rebound.
Investors near or already in retirement may not want to deal with the stress of having to wait for stock market cycles to move to the upside. And with record artificially low interest rates bound to rise, investors may want to consider looking at bonds with near-term maturities (10 years or less). An exchange-traded fund (ETF), such as the IQ Real Return ETF (NYSEARCA:CPI) that hedges against U.S. inflation, as represented by the Consumer Price Index, is another option.
If age and risk weren’t issues, commodities could find a solid position in your asset allocation. Because commodities operate, for the most part, outside of the economy and interest rates, investors can realize big gains or losses. For example, cocoa could become scarce on the heels of political unrest in Ghana or Cote d’Ivoire.
Asset allocation is important, regardless of age, because it spreads risk out. It also helps protect against changing market conditions and the ebb and flow of individual asset classes.
This article is brought to you courtesy of John Whitefoot from the Daily Gains Letter.