2 Key Investing Strategies You Should Practice

Summary

Investing requires taking some risk, but you can help limit that risk with two essential strategies: asset allocation and diversification.

Here’s how they work:

Asset Allocation

How you divide your portfolio among different asset classes (such as stocks, bonds, and cash) is one of the most important decisions an investor makes. The appropriate asset allocation for you is determined by two factors: when you’ll need the money and your tolerance for risk.

Stocks vs. Bonds

Stocks typically are higher risk but can provide greater return over bonds and cash over a full market cycle. Bonds typically offer a lower return than stocks but may provide stability to a portfolio. Cash or cash equivalents, such as certificates of deposit and money market funds, may not keep up with inflation but provide liquidity.

Younger investors saving for retirement have more time to recover from market downturns, so they may choose to allocate a greater portion of their portfolio to stocks compared to investors nearing or in retirement, who may choose to gradually add more bonds and cash to their portfolios. Over the full market cycle, investors may need the growth that stocks tend to provide in order to keep up with inflation.

So, what should be your asset allocation? One general guideline is to subtract your current age from 120 to find what percentage of your portfolio should be in stocks. For example, the portfolio of a 30-year-old would be 90% stocks and the rest, say, in bonds. A 60-year-old’s portfolio would be made up of 60% stocks with the balance largely in bonds along with some cash.

Diversification

No one can accurately predict which investments will perform best year after year. So, many opt to diversify within asset classes.¹ You might, for example, hold stock in small, medium, and large U.S. and foreign companies in different sectors, such as utilities, energy, technology, real estate, and health care. This way if energy stocks tank, any losses you suffer may be offset by gains in other sectors.

You can also diversify your bonds by investing in different types. For instance, you can invest in bonds with different maturities that are issued by corporations, municipalities, and the U.S. government.

Of course, this may seem like a lot of work for busy individuals. You can simplify this by investing in a target-date fund², which is offered in many workplace retirement plans. You can choose the fund with the date that’s closest to your anticipated year of retirement, and the fund’s manager handles the asset allocation and diversification for you.

Disclosures

¹Diversification does not protect an investor from market risks and does not assure a profit. An investor must consider the risk associated with all investments used to diversify assets.

²Please note that the Target Funds are not a complete solution for all of your retirement savings needs. An investment in a Target Fund includes the risk of loss, including near, at, or after the target date of the applicable Target Fund. There also is no guarantee that a Target Fund will provide adequate income at and through an investor's retirement. Selecting a Target Fund does not guarantee that you will have adequate savings for retirement.

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