It's important to understand the different asset classes and the role they may be able to play in your financial strategies. Many financial experts believe that asset allocation may be the single most important factor influencing long-term investment returns, regardless of short-term market fluctuations.* You could potentially lower your investment risk and increase your chances of meeting your investment goals by maintaining an asset allocation that includes several different types of assets.
What Is Asset Allocation?
Asset allocation refers to the mix of different types of investments, such as stocks, bonds, and cash. Because each type of asset has unique risk and return characteristics, the asset allocation an investor chooses is typically determined by that investor's financial goals, time frame, and personal tolerance for investment risk.
Here's a closer look at the risk and reward characteristics of the major asset classes.
Your precise asset allocation needs may change throughout life, but your need for an appropriate asset allocation never goes away.
- Stocks: Over the short term, stock investments typically carry a relatively high level of market risk, or the risk that an investment's value will decrease. However, stocks have historically earned higher average annual returns than other asset classes over longer time periods. Although past performance is no guarantee of future results, stocks may have the potential to generate long-term returns that outpace inflation at the highest rate through the years.
- Bonds: In general, bond investments may be less likely to experience severe short-term price swings than stocks, and therefore may offer lower market risk. On the other hand, bonds' overall inflation risk may be higher than that of stocks, because bonds' long-term return potential may be lower. Inflation risk is the risk that an investment's rate of return will not exceed the rate of inflation, effectively reducing the purchasing power of that investment over time. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
- Cash investments: Among the most stable of all asset classes in terms of returns, money market instruments generally carry very low market risk. At the same time, they don't typically have the potential to outpace inflation by as wide a margin as stocks or bonds.
Dwight Lee and Zelalem Girma are LPL Financial Consultants located at NuVision Federal Credit Union. If you have any questions or would like to make an appointment, please call Dwight Lee at 714.375.8227 or Zelalem Girma at 714.375.8222. Click here to schedule an appointment.
Representatives are not tax advisors or legal experts. For information regarding specific tax situations, please contact a tax professional. For legal advice, consult an attorney. Securities offered through LPL Financial, Member FINRA/SIPC. Insurance products offered through Kinecta Financial & Insurance Services, a subsidiary of Kinecta Federal Credit Union. CA Insurance License #0E24631. Insurance and investment products: 1) are not NCUSIF insured; 2) are not obligations of or guaranteed by the credit union or any affiliated entities; 3) involve investment risk, including possible loss of value. Kinecta Financial & Insurance Services and Kinecta Federal Credit Union are not affiliated with LPL Financial. Some insurance products available to California residents only.
*Asset allocation does not assure a profit or protect against a loss in a declining market.
© 2011 McGraw-Hill Financial Communications. All rights reserved.
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