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What Is Asset Allocation?

Learn about asset allocation in this Howcast finance video from expert Gregory McGraime.

Transcript

Asset allocation is really the process of you as an investor investing in different types of investments to help balance out your risk. So for example, instead of investing all of your money just in stocks, you might invest some of your money in stocks and some of it in bonds as a way of creating balance. So asset allocation is all about what investment plan you're following, and how can you diversify your investments in such a way that you're balancing out the risk in a way that's appropriate for your situation.

So how do you determine your asset allocation? Based on a few things. Number one, how much time you have, right? Somebody that's got 20 years until they can retire can invest a lot more aggressively than someone that's retiring next year because they have 20 years to outlast the ups and downs of the market. If I'm retiring next year and I have all of my money in the stock market and stocks do terrible, I'm in big trouble. I may not be able to retire. So how much time you have is critical. Number two, how do you feel about your tolerance for risk? This is kind of the ""sleep at night factor"" so to speak and everybody's different here. Some people look at their investments and when the stock market is going up and down, they don't mind it. It's kind of out of sight, out of mind, I know this is a long term thing. Other people get very stressed out about this. You know, I'm up at night, worrying about this, I'm complaining to my spouse. It's creating stress for me on an emotional level. So if I feel that personal risk a lot more, then I should invest more conservatively, and usually the way you invest more conservatively is by choosing an asset allocation that's more conservative.

So let me give you an example. Whether you have $1,000 or $1,000,000, the most aggressive way you can invest your money is to put all of it in stocks and none of it in conservative areas like bonds and cash. The most conservative way you can invest is the opposite. I'm not going to have any money on the stock market. But for most investors, a rule of thumb in how to choose an asset allocation plan that's right for you is to take your age, and that's the approximate percentage that should be in conservative stuff that has nothing to do with the stock market. So for example, if I'm 40 years old, 40% of my money would be in cash investments and bonds and only 60% on the stock market. Now of course that's just a rule of thumb, and you have to take your own situation and your own tolerance for risk before making any situations, but that should give you a good idea to see whether or not your investments are in the right ball park when it comes to your personal asset allocation.

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