Investing in the stock market can be intimidating, even when the economy is booming. While "buy low, sell high" is sage advice for those entering the market, recent global and national events have sent otherwise confident investors on a roller coaster of emotions. It's understandable. There have been several twists and turns in the market this year, and experts are expecting more of the same. But that doesn't mean investors can't protect their hard-earned money with an asset allocation strategy.
Asset allocation allows you to select a mix of investments based on your risk tolerance, financial goals and time horizons. For example, a young conservative investor might spread their investment dollars across assets, with 50% in stocks, 25% in bonds, and 25% in cash and cash equivalents. In the same market, a conservative investor nearing retirement age might spread their holdings as 15% stock, 15% bonds, and 70% cash and cash equivalents.
Here are three benefits of asset allocation in a rocky market:
Reduced Risk
When you spread your investments across different assets, you can offset some of the inevitable market fluctuations. Combine a diversified investment portfolio with a long-term investment strategy to help mitigate the risk of financial loss. The better-performing assets can help soften the impact while allowing riskier assets, which might be more heavily affected by market fluctuations, time to recover.
Selecting a variety of assets is also a smart move since assets don't all react to market fluctuations in the same way. For example, financial advisors are unlikely to recommend that you place all your money in individual stocks. While stocks might decline, debt/fixed income assets might be on the rise — or at least provide stable returns. A combination of stocks and debt/fixed income assets could protect you from debilitating declines.
Potential for Increased Profitability
There is power in diversity. An array of assets offers protection against market downturns. But it allows you to experience the gains made by specific assets during extended growth periods. For example, if you only invest in bonds, you'll miss out on the potential for higher returns with stocks. Both should be considered if you have a long-term investment horizon.
Asset Preservation
Making progress toward your financial goals is exciting. It might also serve as a signal to re-evaluate your investment plan. Doing so might help preserve recent financial gains.
Here are a few other scenarios that benefit from having the right asset allocation.
- An asset mix helps weather changes to your investment portfolio when markets decline.
- A varied portfolio could keep you from experiencing the financial devastation that can result when you only invest in only one kind of asset, such as stocks.
- As your time horizon and goals change, so should your asset allocation. You might consider taking less risk as you age so you can preserve the gains you've made over the years. Or, taking more risk earlier in life might offer an opportunity to further increase your gains. Proper asset allocation could help preserve your gains and guard against further losses. Investing for asset preservation requires discipline. When you have a mixed portfolio, you might be less tempted to sell off assets to stop temporary declines. Focusing on goals that won't be achieved for decades can reduce anxiety, but only when you have the right asset mix and state of mind.
- Checking your portfolio balance daily and watching the highs and lows can keep you on edge. But when you've selected an investment mix that suits your long-term financial goals, you can remain calm, enjoy the ride, and embrace the potential for increased profits.