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Spreading Your Assets Around
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Diversification and asset allocation are the keys to a balanced
portfolio.
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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.
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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.
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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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