Asset allocation refers to how much of any given asset class you have in your portfolio. An older investor might have a retirement asset allocation of mostly fixed income investments whereas a more aggressive investor might have most of their investments in stocks. The basic asset classes of stocks, fixed income and good old hard cash are the building blocks of an investment portfolio. Some other asset classes are real estate and commodities.
How to apply asset allocation
Lots of people make the mistake of thinking you need to choose between all risky assets (stocks) or all safe investments (cash) but in actual fact you should pick a happy medium. Riskier assets like stocks have a higher rate of expected return so if your time horizon is long enough then you don’t want to avoid stocks just because they are more volatile than fixed income or cash.
Sample portfolio asset allocation
In a retirement account with a long time horizon you might want an 80/20 mix where 80% of the portfolio is invested in stocks and 20% is invested in bonds. If this is too volatile for your stomach and you are having a hard time sleeping at night then instead of switching all the stocks to bonds or cash then just change your asset allocation to a less risky profile such as 60/40 where 60% is stocks and 40% is bonds.
How to invest a down payment for a house
If you have money saved up for a house down payment then that probably means you are going to be buying in the next year or two. This is a short term investment and you don’t have time to make up for any losses so it is imperative that this be invested in a guaranteed investment such as a high interest savings account or money market funds.