The key to smart asset allocation – and one of the best ways to manage risk – is to diversify, or "spread the risk" over a variety of investments. Since different types of investments may perform better than others at different times, diversification can help you offset the volatility (and potential losses) of a single investment and take greater advantage of the strengths of several asset classes working together.
To ensure adequate diversification, most investment experts recommend that you include at least three asset classes in your long-term portfolio. Diversifying does not guarantee that you won't lose money, but it can keep you from being overexposed to a major downturn in one type of investment. How much you allocate to each of the asset classes (and the investment options within those classes) will depend on your particular goals and preferences. Of course, diversification is no guarantee against losses.
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Risk and return
At the cornerstone of any savings or investment plan is the relationship between risk and return. As a rule, the potential return on any investment corresponds to its level of risk.
Most experts agree that you shouldn't take too much risk with your pension accumulation. On the other hand, you may want to assume enough risk to build the assets to finance the retirement you want. Maintaining that delicate balance is the challenge of successful asset allocation.
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Your time horizon
When it comes to retirement, your investment perspective should always be long term, because your actual time horizon should extend far beyond the day you actually retire. To keep pace with inflation, your money will have to keep working even after you stop, so you'll need to maintain some growth potential even when you've begun making withdrawals.
How can a long-term perspective affect your allocation decision? If you're just getting started with your retirement savings, you have a longer time horizon to absorb and recover from the ups and downs of the markets. So you may want to consider allocating a greater percentage of your contributions to stocks, which have historically offered greater potential for growth than other options. Past performance, of course, does not guarantee future results.
As you approach retirement, you may be less willing to take risks within your retirement portfolio. Many people move accumulated funds to more conservative accounts at this stage.
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