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The Key to Protecting Your Nest Egg: Asset Allocation

The Key to Protecting Your Nest Egg: Asset Allocation

| September 22, 2016
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Before your retirement nest egg can hatch, you’ll need to have a way of nurturing it and protecting it. The first step you can take toward protecting your assets involves what’s called asset allocation. While many believe asset allocation is based on market fluctuation, it’s important to eliminate this misconception by examining the true definition of asset allocation.

What is an Asset Allocation?

Allocating your assets involves choosing, on a percentage basis, how much of each asset class should make up your portfolio. Asset classes range from stocks, bonds, and cash or cash equivalents, and can be further categorized by sub classes consisting of foreign vs domestic, growth vs. value, and market capitalization. You can choose to invest directly in an individual security or indirectly by investing in a fund that invests in an individual security.  

Why Asset Allocation is Important

By diversifying your investments by asset class, you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value. This, in essence, reduces the risk created when investing in a single asset class. Since each asset class can react to economic events independently of other asset classes as seen in the relationship of stocks and bonds, in which case, they move in opposite directions.

While some asset classes will experience success for an extended time period, the length of such performance cannot be predicted. By having a diversity of asset classes, also known as diversification, then portfolio percentages can be reallocated when an asset classes decreases in performance without major losses.  

How Asset Allocations Are Made

Licensed financial advisors can make adjustments to asset mixes recommended for portfolios on a regular basis, based on the current market environment. For example, an advisor might suggest that you increase your cash allocation by a certain percentage and reduce your equity holdings by a similar percentage during times when interest rates increase or international tension exists.

Asset Allocation vs. Market Timing

Reallocating your asset classes as needed is not the same as market timing, which tends to involve making frequent shifts in your portfolio holdings in anticipation of how markets will perform. Since market performance cannot be predicted, the technique of shifting holdings based on market timing rarely produces positive long-term results. 

The Financial Industry Regulatory Authority. Products and Professionals - Key Investing Concepts. http://www.finra.org/investors/asset-allocation. Accessed 12 Sept. 2016.

The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Please consult a licensed financial advisor for specific information regarding your individual situation.

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