Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.
Is it just me, or has summer recently become the most unsettling time of year? It seems like we spend the entire season getting bombarded with all sorts of bad news — killer heat waves, devastating storms, massive wildfires, epic oil spills, and, of course, a steady stream of unsettling economic reports.
The news is a lot like the weather. You can’t change it, but you can prepare to make the best of it. In the financial area, that means doing your best to balance risk versus reward in these turbulent times. The most reliable way to do that is with asset allocation.
Asset allocation is an investment strategy that attempts to balance risk versus reward by spreading the investor’s money across several classes of investments that perform differently in various market conditions. This creates a sort of damper that helps insulate the portfolio from market volatility.
For example, when the stock market is careening down, and your large growth stocks are falling 5 percent in a month, another asset category — bonds or gold — might be going up in value while your cash holdings remain stable, thus offsetting your stock losses. On a day like June 1, when the S&P 500 was down more than 2 percent, a well-managed asset allocation portfolio might have dropped just 1 percent or less.
Exactly how money is allocated to various assets will depend on several factors, including your tolerance for risk and life circumstances. An investor nearing retirement or facing a college tuition bill will invest differently than a 26-year-old single professional. An asset-allocated portfolio should be structured to reflect the owner’s financial time horizons. Cash that might be needed in the near-term can be placed in low-risk assets that offer easy access, while funds intended for a longer-term goal, such as retirement, can be placed in a somewhat more aggressive vehicle. The net result of this “diversification and allocation process” is a portfolio that delivers a steady return and freedom from worry about the latest financial headline.
Regardless of how the money is allocated, an asset-allocated portfolio can be turbo-charged by reinvesting the income it generates — the dividends, interest and distributions paid by the stocks, bonds and other holdings.
For more about asset allocation, also known as “The Bucket System,” check out this blog post.
– By Wes Moss, for Atlanta Bargain Hunter