The Basics of Portfolio Allocation
How you allocate your portfolio is the most important investment decision you will make. Both the asset classes you choose to invest in and the proportion of your portfolio allocated to each class will be the primary determinant as to whether you achieve your financial goals or not.
In this month’s column, I explain what portfolio allocation is and give you basic starting points based on your risk tolerance.
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What Is Portfolio Allocation?
Portfolio allocation encompasses the classes of assets included in a portfolio and the proportion of investment dollars assigned to each asset class. An asset class is a broad category of related securities. Asset classes include equities (stocks), fixed income, commodities (gold, oil, etc.), real estate and alternative investments (venture capital, etc.). Within each asset class are various types of investments. For example, equities encompass individual stocks, stock options, stock-based mutual funds and stock-based exchange-traded funds . The key concept to remember is that an asset class is a broad category covering many types of assets.
Portfolio allocation involves determining what percentage of a portfolio should be allocated to each asset class. These decisions are based on when the money will be needed for withdrawaland the size of the portfolio (wealth). An investor with a low risk tolerance (shorter period until the money will be withdrawn and lesser wealth) should follow a strategy that places a greater emphasis on income and capital preservation. An investor with a higher risk tolerance (a longer period until the money will be withdrawn and greater wealth) should follow a strategy focused more on increasing wealth.
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