Was Miguel Cervantes’ Don Quixote fighting imaginary windmills or market volatility when he said, “Don’t put all of your eggs in one basket?” Putting all of your assets in one basket doesn’t keep them as safe as you might think because there is always a risk that you might lose them all at once.
The way to counter this is the investment strategy of asset allocation. Asset allocation, or diversification, may be even more important than picking the “right” stocks.
The idea is to diversify your money among different types of assets, such as equities, fixed income, and cash and its equivalents, rather than putting all your money into one single asset class.
Minimize potential losses
The main reason for practicing asset allocation and having a diversified portfolio is to minimize potential losses. If you invest in a single asset class, and it does badly, you could sustain a heavy loss. However, if you spread your investments among different asset classes, if one class performs poorly, your losses could be mitigated by holdings in different, hopefully better-performing asset classes. For example, historically, when bonds tend to have low interest rates, stocks rise in value, and in periods of high interest rates, bonds outperform stocks. Of course, past performance is no guarantee of future returns.
How to determine your asset allocation
How do you choose which asset classes to invest in, and in which proportions? This depends on your personal situation and goals. If you want to save for a specific, short-term goal, you would put more of your money into liquid assets that minimize jeopardizing the principal, such as certificates of deposit (CDs), money markets, or cash. However, if you are investing for the long term, you might include a larger proportion of stocks and other growth investments in your portfolio. As the goal is more long term, you have more time to ride out market fluctuations.
To find out more about asset allocation and the importance of having a diversified portfolio, read this.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published May 15, 2017.