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Spreading Your Assets Around

Diversification and asset allocation are the keys to a balanced portfolio.

It's an old saying that's worth repeating: You don't want all your eggs in one basket. The same rule applies to investing. If you put all your principal in one investment, then your financial security rests on the strength of that single investment.

In order to diffuse certain types of risk, you need to allocate, or spread your assets among a number of asset classes. The more carefully you allocate, the less likely that your portfolio as a whole will suffer if one or two categories of investment perform poorly. One way to think of asset allocation is as a shock absorber that works the way shock absorbers do on a car, helping to offset the bumps in the road. But remember that shock absorbers can't provide total protection in a falling market.

THE BIG PICTURE Allocating the assets in your portfolio is a process.
Create a plan for accumulating the money you'll use to invest. Set up an investment account you can build with periodic deposits, identify investments you can add to regularly, even in small amounts, and earmark at least a portion of all gifts, bonuses, or other windfalls for investing.	Match categories of investments to specific goals. If you are investing long term for retirement, you may want to consider equity investments, including stocks, stock mutual funds, and variable annuities. And, you might buy fixed-income investments, such as Treasury or municipal bonds or fixed annuities to balance your stock investments.
Define your goals. To identify the right mix of investments for your portfolio, you have to know what you want to achieve and how much time you have to reach your goals. When you have a specific goal to aim for, it's easier to allocate your assets to help you meet it.	Choose specific investments within each category. Finding the right stocks, bonds, mutual funds, or annuity is the final step in building your portfolio. You can evaluate investments based on their past performance and future potential.

NO SCATTER SHOTSAsset allocation doesn't mean making random investments or simply accumulating a lot of investments for the sake of owning them. In fact, it's just the opposite. Allocation is about finding the right mix of asset classes to match your goals, given your age, the amount you have to invest, and your risk tolerance. Then you'll be ready to diversify your portfolio within each asset class.

INSTANT DIVERSIFICATIONMutual funds and variable annuity separate account funds are diversified investments that offer a way to expand your portfolio with holdings that can be difficult to amass on your own, including international stocks or mortgage-backed bonds.

These funds and accounts offer the benefit of diversification within an asset class or sometimes across classes. Typically, an equity fund owns shares in 60 to 100 or more companies across a range of products and services, though the number does vary. A balanced fund might own 60% equities and 40% bonds, while an index fund owns all of the securities in the market index it tracks. Separate account funds similarly have a specific objective and own a range of investments within a particular asset class.

One caution is worth heeding, though. If you build a portfolio with three different large-company growth funds, you're not as diversified as you would be with one large-company fund, one small-company fund, and a fund focused on buying shares in undervalued or out-of-favor companies. Among other drawbacks to owning three funds with the same objective is that they are likely to invest in many of the same securities.

ASSET ALLOCATION
Once you decide on the asset classes to invest in, you have to decide how much of your investment dollars will go into each investment type. In other words, you have to create a model of how you will divide your investment principal.

Allocation models differ depending on your risk tolerance, timeframe, and goals. Generally, the younger you are, the more heavily weighted toward equities your portfolio may be, since you're seeking long-term growth. A fairly aggressive investor in her 30s, for example, might have 80% of her portfolio in stocks, while a conservative investor in his 60s might have 60% of his portfolio in fixed-income investments.

Since some growth is important in all portfolios, even the most conservative investors and those well into retirement are generally wise to allocate at least a small percentage of their assets to equities with growth potential.

DIVERSITY WITHIN
A diversified portfolio typically has a mix of stocks, bonds, and cash, including the mutual funds and variable annuity separate accounts that belong to each of the asset classes you're including.

In other words, within the universe of stocks, the portfolio would contain stock in a variety of companies, of different sizes, and in different businesses. Similarly, investments in international or multinational companies may be a good way of adding further diversification to your portfolio because they don't necessarily respond to the same economic factors as domestic companies. However, you need to be aware of currency risk and the potential for political unrest when you invest abroad.

The same range is appropriate in each of the other asset classes. Bonds are issued by different types of companies, pay different rates of interest, and have different credit quality. Some mix of those alternatives is likely to serve you better than a portfolio made up entirely of Treasury bills or mortgage-backed bonds.

REBALANCING YOUR ASSETS
After you've decided on an allocation, you'll probably have to realign your portfolio from time to time to maintain it. If your stocks do particularly well in one year, for example, your allocation may be more heavily weighed toward equities than it was originally, as the chart to the right illustrates. That means your portfolio will be potentially more volatile.

To rebalance, you can sell some stock and reinvest the money in bonds or cash, or you can add new investment money to those asset classes rather than to equities. Some mutual fund companies and variable annuity programs offer automatic rebalancing to make the task easier, though you'll pay an additional fee for that service.

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