Diversifying your Portofolio

Even if you find risk exciting, you'll probably sleep better if you've got your investment nest eggs in different baskets.

Diversification helps protect against risk by spreading your investments around instead of investing in only one area For example, you can balance cash investments like CDs and money market funds with stocks, bonds, and stock or bond mutual funds. You can buy stocks of small growth companies while also investing in blue chips, which are the stocks of large, well-established companies. Often when the return is down in one area, it's balanced by a positive performance in another.

You may also want to evaluate your assets and realign the investment mix from time to time. For example, if some stocks increase in value, they will make up a larger percentage of your portfolio. To keep the balance, you may want to decrease your stock holdings and increase your bond or cash holdings.

The Benefits of Diversification

Well-diversified portfolios � containing various mixes of stocks, bonds, mutual funds, cash equivalents like Treasury bills or money funds, and sometimes other types of investments � can help iron out a lot of the ups and downs in investing. And studies have shown that, over lengthy periods, investors didn't have to sacrifice much in the way of returns to get that reduced volatility. Finding the right portfolio mix depends on your assets, your age, and your risk tolerance.

Stocks, Bonds, or Cash? What's the Right Mix?

Recommendations from different investment advisers may vary, as shown by these suggestions from some major investment firms for four individual investors.

The Breadwinner		Firm A	Firm B	Firm C	Firm D
Early 30s, nonearner spouse, two kids. Moderate risk takers, with investment assets of $726,200 (41.6% cash, 6.8% fixed income, 51.6% growth).	Cash	5.8%	11.5%	12.6%	6�25%
	Fixed Income	32.5%	39.7%	25.0%	19�37%
	Growth	61.7%	48.8%	62.4%	61�84%
The DINKS		Firm A	Firm B	Firm C	Firm D
Double income, no kids, late 20s. Moderate risk takers with investment assets of $182,000 (11.5% cash, 66.5% fixed income, 22% growth).	Cash	7.5%	12.4%	27.0%	18�34%
	Fixed Income	33.0%	47.2%	25.4%	33�53%
	Growth	59.5%	40.4%	47.6%	25�41%
The Single Parent		Firm A	Firm B	Firm C	Firm D
Late 30s, one child. Moderate to aggressive risk taker, investment assets of $95,300 (10.8% cash, 20.7% fixed income, 68.5% growth).	Cash	3.8%	14.9%	29.0%	39�51%
	Fixed Income	29.9%	36.4%	37.4%	24�40%
	Growth	66.3%	48.7%	33.6%	18�31%
The Young Achiever		Firm A	Firm B	Firm C	Firm D
Single, mid-20s. Aggressive risk taker, investment assets of $14,000 (60.7% cash, 39.3% growth).	Cash	2.7%	17.2%	45.4%	100%
	Fixed Income	10.9%	26.4%	23.0%	0%
	Growth	86.4%	56.4%	31.6%	0%

Asset Allocation

Asset allocation means dividing your portfolio among investment categories, sometimes called asset classes, according to a particular formula. One allocation model, for example, would put 60% of your investment capital in stocks, 30% in bonds, and the remaining 10% in cash.

No single portfolio is ideal for everyone. While a stock-heavy portfolio may tend to grow faster over time, the value also fluctuates more. It may also produce losses in some years.

And you don't have to stick to the same model throughout your investing career.

Many experts suggest that young people put 80% or more of their investments in stock and stock mutual funds. People nearing retirement, on the other hand, might want more of their assets in income-producing investments, such as US Treasuries or high-rated corporate bonds.

What a Difference an Allocation Makes

Asset allocation can make a real difference in portfolio performance over an extended period. Here's what a hypothetical $100,000 portfolio allocated three different ways and computed using the compound long-term return for three investment types would have gained in a hypothetical year. The returns used in the calculation are 10.4% for large company stocks based on the return of the S&P 500 stock index between 1926 and 2003, 5.9% for long-term corporate bonds, based on the return of the Salomon Brothers Long-Term High Grade Corporate Index for the same period, and 3.7% for cash, based on the return on a US Treasury bill.

Actual annual returns on specific portfolios could be quite different from the average. For example, in 1996 though 1999, portfolios invested 60% in stocks had higher than average returns, while in 2000 through 2002, portfolios invested 60% in stocks had negative returns.

Portfolio A		Portfolio B		Portfolio C
60% stocks		30% stocks		10% stocks
30% bonds	OR	60%bonds	OR	30% bonds
10% cash		10% cash		60% cash
$8,380 return		$7,030 return		$5,030 return