Asset Allocation

Asset allocation is a common strategy that you can use to   construct an investment portfolio. Asset allocation isn’t about picking individual securities. Instead, you focus on broad categories of investments, mixing them together in the right proportion to match your financial goals, the   amount of time you have to invest, and your tolerance for risk.


The idea behind asset allocation is that because not all investments are alike, you can balance risk and return in your portfolio by spreading your investment dollars among different types of assets, such as stocks, bonds, and cash alternatives. It doesn’t guarantee a profit or ensure against a loss, of course, but it can help you manage the level and type of risk you face.

Different types of assets carry different levels of risk and potential for return, and typically don’t respond to market forces in the same way at the same time. For instance, when the return of one asset type is  declining, the return of another may be growing (though there are no guarantees). If you diversify by owning a variety of assets, a downturn in a     single holding won’t necessarily spell disaster for your entire portfolio.

Using asset allocation, you identify the asset classes that     are appropriate for you and decide the percentage of your investment dollars     that should be allocated to each class (e.g., 70 percent to stocks, 20 percent     to bonds, 10 percent to cash alternatives).


Here’s a look at the three major classes of assets you’ll     generally be considering when you use asset allocation.

Stocks: Although past performance is no guarantee of future     results, stocks have historically provided a higher average annual rate of     return than other investments, including bonds and cash alternatives. However,     stocks are generally more volatile than bonds or cash alternatives. Investing     in stocks may be appropriate if your investment goals are long-term.

Bonds: Historically less volatile than stocks, bonds do not     provide as much opportunity for growth as stocks do. They are sensitive to     interest rate changes; when interest rates rise, bond values tend to fall, and     when interest rates fall, bond values tend to rise. As a result, bonds redeemed prior to maturity may be worth more or less than their original cost. Because bonds typically offer fixed     interest payments at regular intervals, they may be appropriate if you want     regular income from your investments.

Cash alternatives: Cash alternatives (or short-term     instruments)     offer a lower potential for growth than other types of assets but are the least     volatile. They are subject to inflation risk, the chance that returns won’t     outpace rising prices. They provide easier access to funds than longer-term     investments, and may be appropriate for investment goals that are short-term.

Not only can you diversify across asset classes by     purchasing stocks, bonds, and cash alternatives, you can also diversify within     a single asset class. For example, when investing in stocks, you can choose to     invest in large companies that tend to be less risky than small companies. Or,     you could choose to divide your investment dollars according to investment     style, investing for growth or for value. Though the investment possibilities     are limitless, your objective is always the same: to diversify by choosing     complementary investments that balance risk and reward within your portfolio.


Your objective in using asset allocation is to construct a     portfolio that can provide you with the return on your investment you want     without exposing you to more risk than you feel comfortable with. How long you     have to invest is important, too, because the longer you have to invest, the     more time you have to ride out market ups and downs.

When you’re trying to construct a portfolio, you can use     worksheets or interactive tools that help identify your investment objectives,     your risk tolerance level, and your investment time horizon. These tools may     also suggest model or sample allocations that strike a balance between risk and     return, based on the information you provide.

For instance, if your investment goal is to save for your     retirement over the next 20 years and you can tolerate a relatively high degree     of market volatility, a model allocation might suggest that you put a large     percentage of your investment dollars in stocks, and allocate a smaller     percentage to bonds and cash alternatives. Of course, models are intended to     serve only as general guides; determining the right allocation for your     individual circumstances may require more sophisticated analysis.


The next step is to choose specific investments for your portfolio     that match your asset allocation strategy. Investors who are investing through a workplace retirement savings plan typically invest through mutual funds; a diversified portfolio of individual securities is easier to assemble in a separate account.

Mutual funds offer instant diversification within an asset     class, and in many cases, the benefits of professional money management.     Investments in each fund are chosen according to a specific objective, making     it easier to identify a fund or a group of funds that meet your needs. For     instance, some of the common terms you’ll see used to describe fund objectives     are capital preservation, income (or current income), income and growth (or     balanced), growth, and aggressive growth. As with any investment in a mutual     fund, you should consider your time frame, risk tolerance, and investing     objectives.

Note:Before investing in a mutual fund,     carefully consider its investment objectives, risks, fees, and expenses, which     can be found in the prospectus available from the fund. Read the prospectus     carefully before investing.


Once you’ve chosen your initial allocation, revisit your     portfolio at least once a year (or more often if markets are experiencing     greater short-term fluctuations). One reason to do this is to rebalance your     portfolio. Because of market fluctuations, your portfolio may no longer reflect     the initial allocation balance you chose. For instance, if the stock market has     been performing well, eventually you’ll end up with a higher percentage of your     investment dollars in stocks than you initially intended. To rebalance, you may     want to shift funds from one asset class to another.

In some cases you may want to rethink your entire allocation     strategy. If you’re no longer comfortable with the same level of risk, your     financial goals have changed, or you’re getting close to the time when you’ll     need the money, you may need to change your asset mix.

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