Insights + Resources

A good investment portfolio will spread your risk

It is an almost universally accepted concept that most portfolios should include a mix of investments, such as stocks, bonds, mutual funds, and other investment vehicles. A portfolio should also be balanced. That is, the portfolio should contain investments with varying levels and types of risk to help minimize the overall impact if one of the portfolio holdings declines significantly.

Many investors make the mistake of putting all their eggs in one basket. For example, if you invest in one stock, and that stock goes through the roof, a fortune can be made. On the other hand, that stock can lose all its value, resulting in a total loss of your investment. Spreading your investment over multiple asset classes should help reduce your risk of losing your entire investment. However, remember that there is no guarantee that any investment strategy will be successful and that all investing involves risk, including the possible loss of principal.

Asset allocation: How many eggs in which baskets?

Asset allocation is one of the first steps in creating a diversified investment portfolio. Asset allocation means deciding how your investment dollars should be allocated among broad investment classes, such as stocks, bonds, and cash alternatives. Rather than focusing on individual investments (such as which company’s stock to buy), asset allocation approaches diversification from a more general viewpoint. For example, what percentage of your portfolio should be in stocks? The underlying principle is that different classes of investments have shown different rates of return and levels of price volatility over time. Also, since different asset classes often respond differently to the same news, your stocks may go down while your bonds go up, or vice versa. Though neither diversification nor asset allocation can guarantee a profit or ensure against a potential loss, diversifying your investments over various asset classes can help you try to minimize volatility and maximize potential return.

So, how do you choose the mix that’s right for you? Countless resources are available to assist you, including interactive tools and sample allocation models. Most of these take into account a number of variables in suggesting an asset allocation strategy. Some of those factors are objective (e.g., your age, your financial resources, your time frame for investing, and your investment objectives). Others are more subjective, such as your tolerance for risk or your outlook on the economy. A financial professional can help you tailor an allocation mix to your needs.

More on diversification

Diversification isn’t limited to asset allocation, either. Even within an investment class, different investments may offer different levels of volatility and potential return. For example, with the stock portion of your portfolio, you might choose to balance higher-volatility stocks with those that have historically been more stable (though past performance is no guarantee of future results).

Because most mutual funds invest in dozens to hundreds of securities, including stocks, bonds, or other investment vehicles, purchasing shares in a mutual fund reduces your exposure to any one security. In addition to instant diversification, if the fund is actively managed, you get the benefit of a professional money manager making investment decisions on your behalf.

Note: Before investing in a mutual fund, carefully consider its investment objectives, risks, charges and expenses, which are outlined in the prospectus that is available from the fund. Obtain and read a fund’s prospectus carefully before investing.

Choose investments that match your tolerance for risk.

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