Wednesday, October 17, 2001

Asset allocation is important

Asset allocation is the key element that determines investment success.

It's not what stocks, bonds, or mutual funds you purchase, nor is it when you buy or sell them. According to the Georgia Society of CPAs, proper asset allocation, the process of systematically distributing your investment dollars among the major asset classes, stocks, bonds, and cash equivalents, determines whether a portfolio performs in line with an investor's financial goals.

Studies have shown that portfolios with investments spread among the three major asset classes perform better and pose less risk than those that concentrate heavily on a single asset type.

That's because each asset class typically responds differently to market conditions and changes in the economy. An event that triggers a decline in bond yields may stimulate a rise in stock prices.

One-year large cap stocks may generate the best returns, while in another year it might be government bonds. When your portfolio includes an appropriate mix of all hree asset classes, you are less exposed to risk because declines in one asset class can be offset by gains in another.

In a nutshell, asset allocation blends the characteristics of the three classes of investments to improve the chances of achieving a desired total return.

To determine what percentage of your investment dollars should be put into each of the three investment categories, you need to consider your investment goals, as well as your tolerance for risk and time horizon.

For example, because a young person saving for retirement has more time to recover from market downturns, he or she can pursue potentially higher returns by allocating a larger percentage of portfolio assets to equities.

That same allocation strategy could prove to be disastrous for a couple soon facing their children's college tuition payments.

When structuring your asset allocation, it is important that you consider all of your investments, including those in tax-deferred accounts such as 401(k) plans and investment retirement accounts, or IRAs.

As you progress through different stages of your life, your asset allocation needs to change along with your circumstances. As you get older, you're likely to adopt a more conservative investment strategy oriented toward preserving capital and earning current income

Allocation and diversificationgo together

Many investors tend to confuse asset allocation with diversification. Asset allocation refers to the process of dividing your investments among the three asset classes, while diversification involves allocating your portfolio dollars among different investments within each of the major asset categories.

You can accomplish diversification in several ways. You might, for example, diversify the investments in your stock portfolio by choosing both domestic and international stocks, large and small capitalization stocks, or growth and value stocks.

For more information, access the Web site at www.gscpa.org

Back to Business Home Page Back to the top of the page