If you’re new to investing, you might want to brush up on the basics of asset allocation, diversification and rebalancing. These three simple ideas can help you save more for retirement and other goals.
Stocks, bonds and cash vary in risk and reward
First, you need to know about the three basic asset classes: stocks, bonds and cash or stable value.
Stocks - These are shares of ownership in a company. These carry greater risks than bonds and cash. Throughout history, stocks have offered the greatest potential for long-term growth.
Bonds - Bonds are debt securities that pay the holder the original amount invested plus interest on a future date. Bonds offer moderate risk and lower returns than stocks.
Cash or stable value - These investments are like bonds but hold money for a shorter time. They offer low risk and lower returns.
Asset allocation helps smooth ups and downs
Spreading your savings among asset classes helps reduce the ups and downs in your account. Asset classes perform differently over time. You may find that the highs in one class balance out the lows of others, smoothing bumps in your account value. Of course, investing carries no guarantees, but asset allocation is a sound concept for building and protecting your savings.
Diversifying also helps balance your portfolio
This idea works with asset allocation. When you diversify, you invest in a variety of asset classes to help balance risk and return. A simple example is an account that holds a stock fund, a bond fund and a cash fund. If one part of your portfolio is doing well and another is losing value, the gains help offset the losses. To diversify further, you could invest in more than one fund in each asset class. And you could pick assets that perform differently depending on the economy.
Rebalancing keeps your plans in place
You may want to check your account and rebalance it from time to time. When one asset class does better than others, it can cause your account to get out of balance.
Say you started with 50% in bonds and 50% in stocks. If stocks did very well and bonds stayed the same, you could end up with 25% in bonds and 75% in stocks.
If you wanted to keep your account balanced at 50/50, you’d need to sell some stocks and buy some bonds to get back to where you want to be.
Some experts suggest you rebalance once a year.
Please note that diversification, asset allocation, or a rebalancing program cannot guarantee a profit or protect against investment loss.