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There’s a lot of jargon in the world of finance that the average person doesn’t understand. One of the common ones is asset allocation.
Below we answer the common question what is asset allocation? Plus we’ll look at different types of assets to help drive the concept home even more.
And we do it in a way that’s easy to understand (we promise!).
Asset allocation refers to the spreading the money you want to invest out among different types of assets. This includes certain things such as equities (like stocks), fixed-income (like bonds), and others we’ll cover in a minute.
Each type of asset has different levels of risks and rewards. And each tends to respond differently to the different trends in the market.
The idea behind asset allocation is to reduce the overall risk of your investments. If one type of asset is subject to big swings in value (up or down), you balance that out with other types that are more stable.
Here are some of the main types of assets for investors.:
Cash – is considered to be the least risky asset. But despite that, the reward is also not great once you take out the cost of inflation.
Bonds – All types of bonds are fixed-income investments. The risks and rewards of bonds will differ depending on the type. But, overall, they are fairly stable.
Stocks – Stocks are the most volatile of the three. And, if you don’t know what you’re doing, can lead to the biggest losses. However, historically, they will give you the best returns on your money.
However, those three are not the only assets. There are also other assets such as:
Real Estate – This refers to your investment in real estate such as rental units.
Derivatives – This type of asset offers the greatest risk and reward, even greater than stocks. You need to be super careful here because you can lose more than what you invested.
Commodities – There are many subtypes of commodities including soy, natural gas, precious metals and more. The risks and rewards can vary depending on the type of commodity.
Currencies – You can invest in currencies of many countries around the world. You can trade them via Forex.
Asset allocation is a process and a strategy for your investments. This strategy is about balancing the risks and rewards per asset.
There is no such thing as a perfect asset allocation for everyone. The ideal mix of your assets should be based on three main things. They are your goals, risk tolerance, and investment horizon.
For example, a person saving money to buy a house, should keep a good chunk of that money in cash. Someone saving for retirement money that may be a few decades away is better off investing heavily in stocks (based on past performance).