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Determining Your Asset MixIntroduction
You've built your emergency fund, determined your goals and their costs, and thought about how much risk you can take. But how do you know which securities to buy? Which ones are going to get you where you need to go?
Before you begin choosing individual mutual funds and/or stocks, you need to think in broader strokes. You need to consider your asset allocation.
Your asset allocation is your portfolio's blend of stocks, bonds, and cash. Finding the best asset mix is crucial if you want to meet your goals. In fact, most financial advisors agree that setting up the right asset mix is more important than choosing great investments. Determining your asset allocation is easier than ever before, thanks to a variety of online calculators and tools.
This course will show you what you need to know before determining your asset mix. It will also discuss the limitations of online asset-allocation tools.What You Need to Get Started
No matter which asset-allocation tool you use, you'll need to know a few bits of information first. For starters, you need to know your goal. Let's say it's to have $1,000,000 when you retire. You then need four pieces of information about that goal to determine your asset mix.
1. The number of years until your goal is reached. You want to retire in 30 years. That's the number of years to your goal.
2. How much money you need for your goal. You want to have a $1,000,000 lump sum when all is said and done.
3. How much money you can invest right now. You have $20,000 set aside, so that's your starting amount.
4. How much money you can contribute each month. You can invest $800 per month.
While some online asset allocation tools will require additional information, many will get you in the ballpark with these key pieces of data.Improving the Odds
Most online tools will give you some idea of your likelihood of meeting your goal, given the inputs of time horizon and your contributions today and in the future. However, you may find that your goal is unattainable with the inputs you submitted. There are some things you can do to improve your chances of meeting your goal.
Invest more now. If you can invest $30,000 now instead of just $20,000, your odds of having $1 million in 30 years improve.
Increase your monthly contributions. Maybe you can't come up with an extra $10,000 now. But if you invest an extra $200 each month, your chances of reaching your goal improve.
Extend your number of years. Maybe you can't put in more money at all but can wait an additional five years before retiring. That would help, too.
Become more aggressive. If you can't invest more money or time, try changing your portfolio mix by increasing your weightings in equities. But be sure to notice what becoming more aggressive means to your portfolio’s volatility over time.Limitations of Asset-Allocation Tools
While online tools certainly make asset-allocation decisions easier, they have their limitations.
For example, if you use six different online asset-allocation tools, you're likely to get six different recommendations for what your asset mix ought to be. Why? Because every tool uses a different set of assumptions.
For example, different tools use different inflation rates, and some will even allow you to choose your own rate. Different assumptions lead to different results. Online asset allocation tools must also make assumptions about what various asset classes will return in the future.
Further, most online asset-allocation tools don't take taxes into account. That's because each investor's tax situation is different. But in the real world of investing, taxes are a huge issue. Realize that the final portfolio values you get from these various tools are generally pretax.
Despite these limitations, sampling an array of online asset-allocation tools, as well as seeing what asset mixes target-date funds employ for people with your same target date, is a good way to get your asset allocation in the right ballpark.
|1||Investment professionals say which of the following is more important?|
|a.||Your asset allocation|
|b.||Which securities you choose|
|c.||Both are equally important|
|2||If you want to improve your chances of meeting your goal, what can you do?|
|a.||Invest more money now|
|b.||Shorten your time horizon|
|c.||Become more conservative|
|3||If you become more aggressive with your investments, which of the following is likely to occur?|
|a.||Your risk will decrease|
|b.||Your risk will increase|
|c.||Your risk will stay the same|
|4||If you're uncomfortable taking on more risk, what can you do to improve your chances of meeting your goals?|
|a.||Invest more each month and decrease your exposure to bonds/cash|
|b.||Decrease your exposure to bonds/cash and lengthen your time horizon|
|c.||Invest more each month and lengthen your time horizon|
|5||Which is NOT a limitation of online asset-allocation tools?|
|a.||They all use different assumptions.|
|b.||They don't usually take your tax situation into account.|
|c.||They don't consider your time horizon.|
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