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>Asset Allocation
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Asset Allocation: A Sound Investment Strategy
Every investor has an asset allocation. Some people just let
theirs happen, others choose theirs. The best allocations are those
that are chosen wisely and designed to fit specific investment
needs. Here's what you need to know to start thinking about
yours.
Asset allocation starts with the universe of investments. That
universe is made up of different types, called asset classes. Some
asset classes give you the potential for strong returns but also
carry the possibility of significant volatility. Others may be very
consistent in value but produce relatively little return. Any
combination of asset classes can serve as ingredients in investment
portfolios.
Asset allocation is the art and science of choosing these
ingredients. Your allocation will define which investments you
choose to emphasize, and how much of each you plan to use. Research
suggests that this decision may be the most fateful choice you can
make in building a portfolio to meet your needs.1
The Main Asset Classes: Stocks, Bonds, and
Money Markets
Here's a closer look at each:
- Stocks -- Well known for fluctuating
frequently in value, stocks carry a high level of market risk (the
risk that your investments' value could decrease). However, stocks
have historically earned higher returns than other asset classes by
a wide margin, although past performance is no predictor of future
results. Stocks have also outpaced inflation -- the rising prices
of goods and services -- at the highest rate through the years and
therefore carry very low inflation risk.
- Bonds -- In general, these securities have
less-severe short-term price fluctuations than stocks and therefore
offer lower market risk. On the other hand, their overall inflation
risk tends to be higher than that of stocks, as their long-term
return potential is also lower. Bond returns may also be influenced
by changes in interest rates. Rising rates are associated with
falling prices, and vice versa.
- Money market
instruments2 -- Among the
most stable of all asset classes in terms of returns, money market
instruments carry very low market risk. At the same time, these
securities don't have the potential to outpace inflation by as wide
a margin through the years as stocks.
How They Performed
(1990-2019) |
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Different investments offer different levels of potential
return and market risk. Unlike stocks and corporate bonds,
government T-bills are backed by the full faith and credit of the
United States, although money market funds that invest in them are
not. Past performance is not indicative of future results. |
Source: ChartSource®, DST Retirement Solutions,
LLC, an SS&C company. For the period from January 1, 1990,
through December 31, 2019. Large-cap stocks are represented by the
S&P 500 index. Midcap stocks are represented by a composite of
the CRSP 3d-5th deciles and the S&P 400 index. Small-cap stocks
are represented by a composite of the CRSP 6th-10th deciles and the
S&P 600 index. Bonds are represented by the Bloomberg Barclays
U.S. Aggregate Bond index. Cash is represented by a composite of
the yields of 3-month Treasury bills, published by the Federal
Reserve, and the Bloomberg Barclays U.S. Treasury Bill 1-3 Month
index. Foreign stocks are represented by the MSCI EAFE index. The
"60/30/10" portfolio is composed of 60% stocks (S&P 500 index),
30% bonds (Bloomberg Barclays U.S. Aggregate Bond index), and 10%
cash (a composite of yield on 3-Month Treasury Bills and the
Bloomberg Barclays U.S. Treasury Bill 1-3 Month index). It is not
possible to invest directly in an index. Index performance does not
reflect the effects of investing costs and taxes. Actual results
would vary from benchmarks and would likely have been lower. Past
performance is not a guarantee of future results. © 2020
SS&C. Reproduction in whole or in part prohibited, except by
permission. All rights reserved. Not responsible for any errors or
omissions. (CS000137) |
From a Bunch to a Pattern
The process of creating an asset allocation begins with a goal
and a time frame for reaching that goal. Goals that are further in
the future allow you to take larger risks in pursuit of greater
rewards. Goals that are more immediate require you to give greater
emphasis to assets that can help you preserve what you have. In
practical terms, that suggests:
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A young person saving for eventual retirement might have a
larger proportion of stocks and relatively smaller portions of
bonds and money market instruments;
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Retirement savers in the middle of their careers might want to
shift some portfolio emphasis to bonds from stocks; and
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Those nearing retirement might want less in stocks and bonds,
and more in money markets or their equivalents.
Asset allocation does not ensure against risk of loss. What's
more, portfolio allocation plans can be very personal, so
individual portfolio recipes can differ. Among the other factors to
consider are your investment judgments and your comfort with risk.
But regardless of the asset allocation strategy you choose and the
investments you select, keep in mind that a well-crafted plan of
action over the long term can help you weather all sorts of
changing market conditions as you aim to meet your investment
goals.
Asset allocation and diversification do not ensure a profit or protect against loss.
1A landmark study shows that about 90% of the variability of returns earned by balanced mutual funds and pension plans over time was the result of variation in asset allocation policy. Source: Financial Analysts Journal, "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?," January/February 2000.
2An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other federal government entity. Although the fund may seek to preserve the value of your investment at $1.00 per share, there can be no guarantee that the fund will maintain it. It is possible to lose money by investing in a money market fund. A fund's yield will vary.
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Mutual funds that invest in short-term money market instruments, such as U.S. Treasury bills, commercial paper, certificates of deposit, and repurchase agreements. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
The portion of a security's overall variability that can be attributed to the variability of the market as a whole.
The risk that the purchasing power of savings will decrease due to rising prices.
Shares issued by large companies, typically those with market capitalizations of $10 billion or more.
An investment vehicle representing a loan to a corporation, government entity, or municipality. Bonds typically pay a fixed interest amount on a predetermined schedule and return their investment principal at maturity. Bonds issued by the U.S. government are backed by the full faith and credit of the United States. Other bonds are backed by the financial strength of their issuers and carry varying degrees of credit risk.
The process of dividing investments in your portfolio among different kinds of assets, such as stocks, bonds, real estate, and cash, to try to meet a specific objective.
A market index used by individual investors, portfolio managers, and market researchers to determine how a particular market or market sector performs.
The day-to-day (or year-to-year) fluctuation in the value of publicly traded securities and, by extension, broad markets.
Short-term debt securities issued by the U.S. Treasury, "T-bills" sell at a discount to their par (face) value and mature in less than a year. The interest an investor earns is the difference between the buying price and the amount paid at maturity.
A share of ownership in a company, typically traded on one or more exchanges. Owners of stock usually receive voting rights on issues affecting the company and may receive a portion of the company's profits in the form of dividends.
Shares issued by small companies, typically with market capitalizations of $2 billion or less.
Content is provided by Wealth Management Systems Inc. as a service to Wells Fargo. Copyright © 2021, Wealth Management Systems Inc. All rights reserved.
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