Diversifying your investment portfolio
Identify your goals early and know your threshold for volatility.
The ultimate financial goal, of course, is retirement. How soon you retire - and in what style - can be greatly affected by your decisions on asset allocation made earlier in life. In accounting for risk in your asset allocation, it's more productive to think in terms of your tolerance for volatility.
This is because one of the greatest investment risks is the risk of doing nothing - and missing out on superior returns.
Those retiring in 15 years but with little tolerance for wild swings may want to keep 50% in stocks and 40% in bonds, with 10% in a money market account.
If this person is planning to retire in 25 years, he or she might ratchet the equities holdings up to between 70 and 80%.
Those retiring in five years are faced with the daunting task of allocating their assets for maximum return without betting the farm. A nasty market dip could occur immediately before retirement, leaving your nest egg drastically short.
Achieving the right mix of stock types (small-, mid-, and large-caps) and bonds (short-, medium-, and long-term) to achieve maximum return for your volatility tolerance while maintaining adequate diversification is a tricky business, so you may want to consider consulting a qualified financial planner or adviser.
Before you actually invest in accordance with your newly minted allocation plan, you will want to do something that few individual investors do: Find out specifically what you own.
Most people don't know precisely what they own because their portfolios are dominated by an accumulation of mutual funds. If you strip away the marketing veneer of each fund and do some investigating, you can not only find out what the fund says it invests in, but also what it actually owns.
For example, some funds may call themselves small-cap. But, these same funds may veer into large-cap territory to boost their returns if their sector is out of favor. Your fund's 800-number reps should be able to give you information on this.
The need to determine what you already own is another reason to hire a qualified financial adviser; he or she would have a good handle on most funds. As your adviser would tell you, you must break these funds into their component parts to know what percentage of your assets is in small caps versus large, or in long-term bonds versus short-term.