Asset Allocation and Diversification

Asset Allocation

Asset allocation is the process of your dividing investment dollars among different asset classes, such as stocks, bonds, and cash (money market securities), to seek to obtain investment returns based on your risk tolerance.

When determining and reevaluating your investment portfolio’s asset allocation, remember that stocks, bonds, and money market securities generally do not move in sync. This is why diversification, risk tolerance, and rebalancing should be part of your overall asset allocation strategy.

The Case for Diversification

Diversification is the essence of asset allocation. Diversification of your assets means putting them in different kinds of places to lessen risk.

Various asset classes have performed differently in different market and economic environments. In the last 10 years, small- and large-company stocks as a class recorded the best gains six times, and government bonds as a class recorded the best gains four times. Of course, the performance of any individual stocks / bonds varied and will vary.

The concept of asset allocation works in tandem with managing investment risk. The goal is that when assets are properly allocated among different types of asset classes, the effects of one asset class can be reduced. To look at this from another perspective, the positive results of one type of investment may help offset the negative performance of another.

Source: Wiesenberger, 2003, for the period 12/31/1992 to 12/31/2002.

• Small-company stocks are represented by the Russell 2000 Index.
• Large company stocks are represented by the S&P 500 composite, a broad-based, unmanaged index that is considered representative of U.S. stocks.
• Government bonds are represented by the average annual yield on 10-year Treasury bonds.
• Treasury bills are represented by the average annual yield on 30-day Treasury bills.

Treasury bills are secured by the full faith and credit of the U.S. government and offer a fixed rate of return, whereas the return and principal value of an investment in stocks, mutual funds, and bonds fluctuate with changes in market conditions; when sold, these securities may be worth more or less than the original investment amount. Past performance does not guarantee future results. The results shown are for general illustrative purposes only and do not reflect investment costs or taxes.