Welcome back to our series on Asset Allocation. In the next few entries, we’re going to discuss the major techniques that you should keep in mind to ensure that you have a properly diverse set of investments to see you into the future.
Remember, if you put all of your investments in the same category, you are prone to sudden losses if that category should face some setbacks. Diversification is key!
Risk And Return
Our first tip concerns the constant parity between risk and return. Each investment you make carries with it a certain attribute that we call the “risk / return tradeoff”. This concept is the very essence of Asset Allocation because it represents the fine balance of diversity that you wish to strike in your portfolio.
For example, most people would say that their goal with investing is to make a lot of money. However, if we only considered those investments that had the highest potential for making money, we might put everything we had into high end stocks. If we did so, we might very well get rich overnight. On the other hand, as history has shown us, we might end up totally penniless.
Balance Your Portfolio
Therefore, it pays to balance out your portfolio with a nice mixture of low risk / low potential and high risk / high potential investments. For example, having a good assortment of bonds, mutual funds and the like would provide a continual, safe stream of income that would act as the core of your investment portfolio and prepare you for the future.
With that in place, you would be much better suited to invest some extra income into the high risk stocks, because in the event that they failed, you would still be left with the safety net of your low risk investments.
By spreading out your assets in this way across the spectrum of risk and potential return, you are getting the most out of your investments.
See you next week for part 3 of Asset Allocation.
Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 – 2009
{ 3 comments… read them below or add one }
This is the perfect companion piece to the previous article on diversification. Balancing low and high risks for the return.
I suspect that following Warren Buffet’s principles would be a safe standard to achieve this.
Hi Sean,
It seems to me that you should build a solid foundation of safe, low risk investments for your portfolio. Then balance it out with those moderate risk strategies all the way to the ones that you can’t sleep over.
I think you need investments that will give you cashflow now and investments that will build you a nest egg for your retirement.
Hey Jazz, you are really getting this now, but we don’t want strategies we can’t sleep over.
Ideally, when we have so much money that we can afford to speculate on high risk, high return investments that we finance with our play money, we will sleep like babies!