1. Your return on investment
2. Your investment risk
Return Vs. Risk
Among the 3 main investment types- stocks, bonds and cash- each asset class has different risk and return characteristics. That means that each are expected to behave differently over time.
Stocks traditionally have the highest return of the main three investment options, but they can also pose the biggest risk factor.
Time Is Your Friend
One way to mitigate the higher risk factor of stock investments is time. Longer time horizons work to lower your risk; if you don’t have to take your money out in the short term, this helps you to ride out occasional downturns while profiting overall in the long term.
Bonds, on the other hand, are considered a lower-risk investment, with typically low volatility over time. The return on bonds tend not to be as high as stocks, but as a low-volatility investment, bonds can help balance out a portfolio’s overall risk.
Finding the Right Mix
How you choose to mix your assets depends on many factors, including your financial goals, your time horizon, and your risk tolerance.
Before deciding on your asset allocation, it’s important to clarify what your goals are, and ensuring that your portfolio is well matched to these goals.
A young investor in his 20s saving for retirement may choose a higher-risk asset mix, such as 60% stocks : 40% bonds because his long-term time horizon insulates him from occasional stock downturns. An investor in his 60s nearing retirement, may want to gradually rebalance his portfolio for lower volatility as he approaches the time when he will withdraw his money.
What is your personal comfort level with risk? It’s important to match your portfolio to your risk tolerance, because the ups and downs of market fluctuations may spark strong emotions that can lead to hasty (and costly) investment decisions. Some investors prefer a more aggressive, higher-risk approach, while others would rather emphasize low volatility and fewer risks.
The good news is, no matter what your goal is, you can find an investment mix that can help you towards your goal. And whether you prefer to choose your investments yourself or partner with a trusted adviser, asset allocation remains a powerful way to affect the potential return and risk of your portfolio.