When you invest for the long term, you're seeking growth over time and can ride out periods of short-term
volatility, which is a measure of how quickly and how much a security's price changes. So you may choose to invest a larger part of your
portfolio
in
equity funds. But as a way to manage risk,
it's a good idea to consider the role of income investments as well. When you're using
mutual funds,
income investing generally refers to bond funds, though you may also consider equity income or
growth and income funds,
or
real estate investment trusts (REITs).
One characteristic of
bond funds
is that they are more likely than equity funds to pay
distributions
monthly. You can reinvest that money in the fund to buy additional shares or, if you own the fund in a regular taxable account, take the distribution as cash. And bond funds, like the bonds they buy, often provide their strongest returns in periods when stocks and stock funds are depressed. The opposite is true as well. So by owning both types of funds, you may be able to moderate losses in one
asset class
with gains in another.
From the opposite perspective, if you're investing primarily for income, as you may be when you've retired, you'll want to consider including some equity funds in your predominately bond fund portfolio. Their potential for growth can help ensure that you have financial resources as long as you need them.
Balanced funds
Balanced funds
are another way to
allocate
your assets. Balanced funds own a combination of stock and bonds, and are designed to provide some growth and some income while offering some protection against the risks of owning either asset class on its own. In fact, if you're just beginning to invest or if you have a relatively small mutual fund portfolio, a balanced fund may be the most appropriate choice.
Safety in bonds?
When the stock market takes a dive, many investors flee toward bond funds. But piling a large portion of your investment dollars into bonds doesn't eliminate all investment risk. Before you make a major change in your asset allocation, you should become familiar with the risks bond funds carry:
When interest rates rise — a sign of a recovering market — existing bonds tend to decline in value, and bond funds may see periods of negative total returns Unlike individual bonds, bond funds don't pay a fixed interest rate and they don't promise a return of principal
Marc Lackritz
Marc Lackritz discusses how appropriate asset allocation and diversification can help you manage risk.
The data make clear that, if risk is the chance of failing to earn a
real return
over the long term, bonds have carried a higher risk than stocks.
By
allocating
and
diversifying
your mutual fund portfolio, and holding that portfolio through the market's cycles, you should be in a stronger position both to accumulate profit and withstand adversity.
Similarly, if you want to use mutual funds as a holding place for emergency funds or for the money you are waiting to invest, you may want to choose a
money market
or short-term bond fund where there's little
inflation
risk and similarly little risk to
principal
. While these funds don't provide enough return to meet long-term goals, they can serve short-term needs well.
Marc Lackritz