Asset Allocation

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Jonathan Clements was a longtime personal finance columnist for The Wall Street Journal, and he offers great advice at the best price you can get (free) on his blog Humble Dollar. Here is one piece of advice from his site:

ASSET ALLOCATION. This is a portfolio’s split between the four asset classes: stocksbondscash investments like savings accounts and money market funds, and alternative investments like gold, real estate and hedge funds. It’s arguably the most important decision an investor makes. The more a portfolio has in stocks, the greater its volatility—but the higher its expected return.”

Like Jonathan mentions above, this is arguably the most important decision you make. Once you make the decision, it solves many of your investing dilemmas.

For example, many people think that the stock market is an overvalued bubble about to burst. What do you do at the end of this month when you are looking to invest some money? You look at your desired asset allocation and invest in whatever is underweighted. If nothing is underweighted, you invest in them proportionally and consistent with your asset allocation. If your desired allocation is 80% stocks and 20% bonds, you invest 80% in stocks and 20% in bonds.

The bubble bursts tomorrow and it’s the end of the month. What do you do? Again, you look at your desired asset allocation and invest in whatever is underweighted (likely stocks).

Picking an appropriate asset allocation and sticking to it simplifies your financial life and solves mental dilemmas.

If you want some help, here’s my take on how to select an appropriate asset allocation. You can also find a discussion about it in our 6th step to financial security – Invest in Stock and Bond Index Funds or ETFs.

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