A wealth of assets is the primary goal of almost everyone, from individuals to small businesses and large corporations. However, any financial advisor will tell you that it's never a good idea to invest all your money in one type of asset -- even cash. You've probably heard of asset allocation, and you may even have a general idea of what it means. But do you know how to make it work for your situation? This guide should help.
What Is Asset Allocation?
Asset allocation is exactly what it sounds like: dividing your wealth into various types of investments. Investor.gov sums it up with the old expression: "Don't put all your eggs in one basket." Have you heard of a diversified portfolio? That's asset allocation.
What Types of Assets Are Available for Allocation?
There are lots of different investments you can make, but the main three categories are:
Most financial advisors recommend utilizing all three, but this advice may vary depending on your situation and how much you have to invest.
Maximize Your Return; Minimize Your Risk
These are the two primary goals of any asset allocation model: Maximize your return and minimize your risk. This is often called the "risk-return tradeoff."
There's always a bit of risk involved when you own any assets, but some types of investments are riskier than others. Cash is generally the least risky, but it also offers the least amount of return. Bonds are only slightly more risky than cash, but returns are usually minimal. Stocks offer the highest returns, but they also have the highest risk. Even within these categories, some investments are riskier than others.
How Much Risk Should You Take?
As you consider the best allocation model for your assets, you'll likely wonder how much risk is best for your situation. This is called your "risk tolerance." Most financial advisors will go over several key factors when determining how much risk you should take:
- How much money do you have to invest?
- When do you want or need to meet your financial goal?
- Are you personally more comfortable with a conservative or aggressive approach?
Usually, most investors choose to invest in a combination of investments that range from highest risk to lowest risk and everything in between. This helps minimize your risk while also increasing the likelihood of a good return on your investment.
Your Next Steps
If you wish to consider different asset allocation models, it's time to plan a meeting with your financial advisor. Once you've settled on a strategy, you'll need to review your position periodically to stay on track for the future.
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