Maintaining a portfolio with a mix of stocks and bonds that suits your risk tolerance and time horizon, a practice known as asset allocation, has been a fundamental tenet of investing for a long time. Although asset allocation does not assure a profit or protect against loss in a declining market, investors who base their investment strategy on a target asset allocation may find it easier to stick with it when the stock market experiences significant ups and downs.
One reason may be that the balance of stocks and bonds helps investors avoid significant losses. Stocks and bonds historically have not moved in tandem in response to economic or market developments, although past performance does not guarantee future results.
Points to Consider
When deciding on a target asset allocation, it may be helpful to consider your risk tolerance and time horizon. Stocks historically have exhibited more short-term ups and downs compared with bonds and other more conservative investments.1Because of this historical trend, a larger allocation to stocks may be appropriate for those who plan to remain invested for the long term and who can tolerate short-term swings in value. Those who may need to access their money in the short term may want to consider a greater emphasis on more conservative investments with the goal of preserving principal.
In addition, feelings about risk also come into play. Some individuals are uncomfortable with investment risk, which is the possibility that the value of their portfolio could decline. Historically, many investors with a low tolerance for investment risk have allocated a larger portion of their portfolios to bonds or cash investments. It’s important to remember, though, that these more conservative investments also carry some risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
Risk is part of investing, and it’s important to understand the potential upside and the potential downside of every investment. That said, a balanced portfolio, may help you stay focused, even when Wall Street seas are choppy.
1Sources: Standard & Poor’s; Barclays Capital. Stocks are represented by the S&P 500, investment-grade bonds by the Barclays Capital Aggregate Bond Index. Past performance does not guarantee future results.
© 2011 McGraw-Hill Financial Communications. All rights reserved.
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