Asset Allocation
Sunday, July 29th, 2007
The last several months have seen many events that have had a substantial impact on the financial markets; and while we won’t see anything like an election in the near future, it is still certain there will be changes and fluxes in the market. With the ever-moving market, it becomes difficult and even counter-intuitive to devise a long-term retirement investment plan and stick with it throughout the changes in the market. If you are reading this newsletter, you have already decided you want to make the best possible decisions regarding your money - Smart401k can position you to profit off the strong markets while minimizing risks in the weaker times.
The first concept to understand in investing is the principle of asset allocation. Once you decide to put your money somewhere other than under your mattress, it is vitally important to allocate your money across diverse segments of the stock market. In economic terms, we call this diversification. Our goal in this article is to help you understand the philosophy and principles of diversification and asset allocation.
The clich© of having all your eggs in one basket is still one of the most powerful and accurate descriptions in the market. Too often employees find themselves happily skipping down the road with almost all of their investments in one particular stock or fund. At certain times these people may enjoy significant growth and appear to be on track to an early retirement, but more often than not the wise investors who adopt a balanced approach by allocating their investments across diverse segments of the market are able to enjoy the growth and performance of the entire market, and over time they will enjoy success with less risk of a major loss of their investment.
But diversification does not just mean throwing a net as wide as possible into the market. It’s also important to weigh your investments in segments of the market to reflect your financial situation and tolerance for risk (risk here is defined as a person’s willingness to take more of a chance for a loss of investment for a larger gain over time).
Smart401k provides recommendations for clients to allocate mutual funds across eight key segments of the market - which are also called asset classes. The asset classes Smart401k currently uses include: cash equivalents, bond (intermediate), balanced, large cap value, large cap growth, small/mid cap value, small/mid cap growth, and international. It’s important to understand that mutual funds in each one of these classes have similar stock and/or bond holdings, and will also behave similarly in the market. For example, to an extent, different large cap growth mutual funds will go up and down together. One fund may perform better than the other, but they will usually move in the same general direction.
In addition, it’s important to know that different asset classes lead the market in performance at different times. There is no one ”golden” asset class that is always better than the others all the time. Many times we will see the asset class with the highest return be different than the year before.
Okay, so now that we know that Mutual Funds are classified into different asset classes, and that each asset class has its own common levels of risk and performance associated with it -“ what’s the big punch line?“ why is allocating investments across a diverse set of asset classes important?
The answer is: Nobel Prize winning studies have also shown that by allocating your investment dollars into certain combinations of asset classes, and investor is able to maximize the performance of their total investment for the level of risk they are taking. In other words – based on historical performance, you can get more for your money with proper diversification and allocation of your investments. This is the foundation principle of Modern Portfolio Theory, and is the basis for the investment allocation recommendations we provide at Smart401k.
No one pretends the world of retirement investing is stress-free or simple. Company retirement plans are a wonderful opportunity for investors to plan for the future. But you can still do the extra work to maximize the returns. By teaming up with Smart401k, your retirement money is allocated and diversified in funds and asset classes that historically have provided the best returns for the level of risk taken.
