Have you ever heard the phrase, “Don’t put all of your eggs in one basket!”? That’s basically what Asset Allocation is. If you put all of your savings (eggs) in just one basket (all in the same place, like all in stocks), and the basket falls, all of your eggs (savings) will be destroyed.
To put it into more technical terms, an investor’s portfolio should be divided into different categories like stocks, bonds, real estate, mutual/index funds, cash or other liquid assets (CD’s, traditional savings accounts and money market accounts), and private equity (like in a home or business). The theory of asset allocation is to protect an investor in the long term, for history has shown us that when stocks are up, bonds may be down. When interest rates are up (CD’s and savings accounts), real estate is down. Diversifying your eggs into more than one proverbial basket will help to keep your personal finances in check for the long haul.
How Much Should Go Where
Asset allocation is different for everyone looking to invest, all depending on the financial goals of the individual. For example, a 22-year old bachelorette will probably have a different view of finances than a 65-year-old grandmother who wants to retire in just 2 years. These individual goals are plugged into an Asset Allocation Model to help the diversification process.
Breaking it down even further, there are four basic asset allocation models that vary depending on what you have and what you want out of it. First, there’s Preservation of Capital , which has nearly no risk whatsoever, for these folks have money and plan on spending it within the next 12 months. This includes those who plan on paying for college and/or buying a home or business.
Second, the Income model is designed for those who need a source of income to live on without losing the principle. Growth would be nice, but living now is the main purpose.
Thirdly, a Balanced model is in the middle of the above two, created with young families in mind (to pay for college and retirement). And lastly, the Growth model is designed for our 22 year old bachelorette to sock away some money for her future plans.
As with all financial issues that might make you nervous, be sure to contact an financial advisor. If possible, find one that is paid at a flat fee rather than on a commission basis to keep them on the “unbiased” side.
