The correct allocation of assets will spread your investments, and therefore your risk, among a bevy of asset classifications, like stocks, bonds and cash. With diversifying, we can take it one step further to see how the investor can spread his investments within these three categories.
An investor might allocate all of his investment dollars to stocks if he is 25 and saving for retirement, or he might put all of it in cash instruments if he is saving for a down payment on a home that he wants to buy in just a few years. But even within the category of stocks or cash, there are many kinds of investments to choose from.
Cash
Cash and cash equivalent investment types are the least risky and may even come with a guarantee. Usually, the investor will not lose more than the original stake, much akin to a savings account. The return depends on the liquidity of the investment. The more liquid, the less return. Therefore, key considerations with cash investments are the length of the investment period along with liquidity and fees.
If a two-year certificate of deposit receives all your cash investment allotment, you will undoubtedly double the return of sinking that allotment into a regular savings account. The downside is that you cannot access certificate of deposit funds until the certificate matures, in the above case for two years, without suffering a significant penalty fee. You may have been better off in this case to keep some of your cash more liquid should you need to withdraw a portion of your cash assets. Treasury bills, money market deposit accounts and money market funds are secure investment vehicles that offer varying degrees of return. The fact is with cash investments, the easier and more rapidly you can access the funds, the less will be your return.
Bonds
A bond is simply a debt instrument - an IOU issued by a local, state or federal government or a large corporation. Bonds are like cash in that they are generally a fine way to preserve capital and they also offer a way to earn income, balance the risk of a stock investment and manage tax liabilities. When interest rates rise, bond prices fall, but your money market investment will gain value. Bond issuers can default, but this is rare for most bonds, and they are also difficult to sell off in a falling interest rate market.
Buying bonds from different issuers with different maturity rates can diversify your bond investments. You need a goodly amount of money to invest if bonds are your thing, as you need at least $10,000 - Treasury securities are in increments of $1,000 and the corporate and municipal bonds are often in increments of $5,000 plus. If you have a lesser amount than $10,000, you may want to look at a bond mutual fund that is already diversified for you.
Stocks
When you consider the long term, over several years, stocks have consistently produced the highest returns and carry the greatest risk. You could get a grand slam homerun or strike out on your first at bat. In the years spanning a full season (baseball) or over an entire career, though, most stocks that have grown in stature will generate a positive return for you. Because of this, stocks are especially good for long-term investments that can go the distance and not for short term-savings that need to be there when it is time for you to make a withdrawal.
Stocks portfolios are typically by buying across various business sectors, such as financial, media, transportation, and entertainment. Care should be taken to ensure that sectors chosen do not all rise and fall based on the same indicators. For instance, automobiles and air travel both decline when the economy is sluggish, but so do restaurants and other industries that depend on consumers' discretionary dollars. Movies tend to do well in hard times, as do essentials such as food and clothing.
You should also consider mutual funds, which are a fine way to avoid the highs and lows of individual stocks by averaging the peaks and valleys across several companies or industries.
An investor might allocate all of his investment dollars to stocks if he is 25 and saving for retirement, or he might put all of it in cash instruments if he is saving for a down payment on a home that he wants to buy in just a few years. But even within the category of stocks or cash, there are many kinds of investments to choose from.
Cash
Cash and cash equivalent investment types are the least risky and may even come with a guarantee. Usually, the investor will not lose more than the original stake, much akin to a savings account. The return depends on the liquidity of the investment. The more liquid, the less return. Therefore, key considerations with cash investments are the length of the investment period along with liquidity and fees.
If a two-year certificate of deposit receives all your cash investment allotment, you will undoubtedly double the return of sinking that allotment into a regular savings account. The downside is that you cannot access certificate of deposit funds until the certificate matures, in the above case for two years, without suffering a significant penalty fee. You may have been better off in this case to keep some of your cash more liquid should you need to withdraw a portion of your cash assets. Treasury bills, money market deposit accounts and money market funds are secure investment vehicles that offer varying degrees of return. The fact is with cash investments, the easier and more rapidly you can access the funds, the less will be your return.
Bonds
A bond is simply a debt instrument - an IOU issued by a local, state or federal government or a large corporation. Bonds are like cash in that they are generally a fine way to preserve capital and they also offer a way to earn income, balance the risk of a stock investment and manage tax liabilities. When interest rates rise, bond prices fall, but your money market investment will gain value. Bond issuers can default, but this is rare for most bonds, and they are also difficult to sell off in a falling interest rate market.
Buying bonds from different issuers with different maturity rates can diversify your bond investments. You need a goodly amount of money to invest if bonds are your thing, as you need at least $10,000 - Treasury securities are in increments of $1,000 and the corporate and municipal bonds are often in increments of $5,000 plus. If you have a lesser amount than $10,000, you may want to look at a bond mutual fund that is already diversified for you.
Stocks
When you consider the long term, over several years, stocks have consistently produced the highest returns and carry the greatest risk. You could get a grand slam homerun or strike out on your first at bat. In the years spanning a full season (baseball) or over an entire career, though, most stocks that have grown in stature will generate a positive return for you. Because of this, stocks are especially good for long-term investments that can go the distance and not for short term-savings that need to be there when it is time for you to make a withdrawal.
Stocks portfolios are typically by buying across various business sectors, such as financial, media, transportation, and entertainment. Care should be taken to ensure that sectors chosen do not all rise and fall based on the same indicators. For instance, automobiles and air travel both decline when the economy is sluggish, but so do restaurants and other industries that depend on consumers' discretionary dollars. Movies tend to do well in hard times, as do essentials such as food and clothing.
You should also consider mutual funds, which are a fine way to avoid the highs and lows of individual stocks by averaging the peaks and valleys across several companies or industries.
About the Author:
For more interesting articles on long term care insurance, financial planning, or other financial topics, please visit Kennard Wealth Management.
No comments:
Post a Comment