When it comes to investing, some of the oldest advice is still the best: Don’t put all your eggs in one basket.
Arguably the single most important thing the novice investor can learn is to divide money among the three different “asset classes”: that is, stocks, bonds, and short-term investments (also known as cash). It’s called “asset allocation,” and it’s what you do when you spread your money across the asset classes in a way that makes sense for you.
Of course, investing in this way neither ensures a profit nor guarantees against a loss. But it can help you get ready for tomorrow while sleeping more soundly tonight. And you can do it in just three steps.
Your first step is to make sure you understand three basic types of investments: stocks, bonds, and short-term investments. These are called “asset classes” and they're the building blocks of a long-term investment mix.
Stocks represent part ownership (equity) in a public company. The price of a stock moves up or down depending on how much investors are willing to pay for it. Stocks have historically provided the highest long-term returns and the greatest risk (although past performance does not guarantee future results).
Bonds represent a loan to a bond’s issuer, which promises to repay principal with interest over the life of the bond. In general, the bond market is volatile, and fixed income securities carry interest rate risk. That means, as interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities. Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. (It’s important to note that, unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.) Bonds are typically less risky than stocks but also provide more moderate potential returns, too.
Short-term investments are designed to preserve your capital. Short-term investments generally pay a modest rate of interest and are considered the least risky of the three investment types. By the same token, they also tend to provide the lowest potential return.
Your investment mix will be a uniquely personal blend. The chart above shows four ways to divide up your investment mix. This chart is merely a place to start, but it does give you a sense for how an investment mix can be matched up with your needs. Whatever you ultimately decide, make sure your choices reflect your financial needs, your comfort with risk, and how long you have to invest your money before you will need it.
The last step is to choose investment options you're comfortable with. As you make your choices, here are two key things to remember:
Try to include more than one kind of stock investment, since stocks respond to market movements in different ways. But make sure you focus on quality over quantity. It’s easier to keep track of your investments if you keep the number manageable.
Instead of chasing short-term performance, look at performance over the last five to 10 years. But remember, past performance can’t guarantee future results.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
The target asset mixes presented above were developed by Strategic Advisers, Inc., a registered investment adviser and a Fidelity Investments company, based on the needs of a typical retirement plan participant.
The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet a participant’s goals. You should choose your own investments based on your particular objectives and situation. Remember, you may change how your account is invested. Be sure to review your decisions periodically to make sure they are still consistent with your goals. You should also consider any investments you may have outside the plan when making your investment choices.
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