So basically, when I started this, I had no idea what this meant. I only wrote this because I eavesdropped on my dad talking to someone about it. Okay, I know I eavesdropped but what harm could be done. But after some intense research, I figured out its meaning and it is…
Spreading your money into different types of investments to reduce risk of you losing your money when you need it the most. When picking out an asset mix, you want to choose investments in the right proportion that maximizes return while controlling for risk. That describes asset allocation.
Stocks, bonds and cash are the common components that make up an asset mix. And depending upon how much time you have to retire, that asset mix could look something like shown below.
How do they decide on the mix? Fluctuation in the value of a portfolio is a key part of choosing an asset mix. Stocks fluctuate a lot more than bonds or cash, but they tend to make the most over time. Bonds don’t fluctuate as much as stocks and cash is just cash. It stays the same.
And if you look at the plot above, you see a pattern. The more years you are away from retirement, the more stocks you own. Then why not buy more stocks when you are in retirement? Keep in mind that stocks tend to drop more frequently so when you need the money to live on, you might be forced to sell stocks at a low point. And once you sell and when eventually stocks recover, you will not participate in the recovery. And that is why you also own bonds and cash.
So that’s asset allocation.
Thank you for reading.
Cover image credit – Andrea Piacquadio, Pexels