Spread the risk
You can also control risk by distributing your
principal among a number of different types of investments, or
asset classes, including stocks, bonds, cash and cash equivalents,
real estate, and derivatives. This process, known as
asset allocation, is based on the fact that most asset classes
not only produce positive returns in different ways, but do so
at different times.
For example, the strongest stock returns, which are normally produced
by a combination of price increases and dividend payments, tend
to occur in periods of strong economic growth, political stability,
and low inflation. In contrast, the strongest bond returns tend
to occur when interest rates are high or when the political or
economic future is uncertain.
Since bonds are likely to be strong in a period when stocks are
weak, and vice versa, it's logical that you'll be better
off having invested some money in each category, rather than placing
all of your money in one category or the other.
One good risk deserves another
The percentages of your portfolio that you allocate to various
asset classes will depend on your age, your time frame for attaining
your financial goals, your risk tolerance, and the changing economic
picture.
Experts agree — and have evidence to prove — that a
portfolio's asset allocation accounts for more than 90% of
its return. Some maintain that, for individual investors, allocation
determines as much as 100% of a portfolio's return.
|
Thomas J. Dorsey, President and
co-founder of Dorsey, Wright &
Associates 
