The goal of this Step-By-Step Guide is to assist you in developing a long-term investment strategy. Certain information herein has been provided by independent third parties whom WTIA believes to be reliable. Although all content is carefully reviewed, it is not guaranteed for accuracy or completeness. In addition, this Guide should not be considered investment or financial planning advice, since only you can decide what your financial goals and requirements are and what your tolerance for investment risk is. Similarly, nothing in this Guide is intended to be estate planning, tax or legal advice, since that type of advice can only be provided by a financial professional in light of your individual circumstances. You should work with a financial professional to develop the specific actions and strategies to reach your retirement goals.
The Importance of Asset Allocation to Today's Investor
We've all heard the old saying, “Don't Put All Your Eggs in One Basket”. Nowhere is that advice more valuable than with regard to investing. By diversifying and using asset allocation as a technique, you can help reduce the overall risk of your portfolio.*
Asset allocation is a time-tested, risk-reducing strategy used to diversify your investments across a mix of “asset classes,” or financial markets — such as stocks, bonds and money market securities — according to your unique situation and goals. It can help you capture the performance of each market — and help reduce the impact of year-to-year fluctuations in any given market.
The graph below illustrates the hypothetical growth of a $1 investment in four traditional asset classes, as well as inflation, over the past 80 years. You can see that large and small asset classes have provided the largest increase in value, while the fixed income investments provided only a fraction of the growth. However, these higher returns are associated with much greater volatility (risk).
Properly diversifying your investment among the right asset classes, as based on your investment goals, time horizon, and risk tolerance is key to your investment strategy.
The graph below provides a simple demonstration of the benefits of asset allocation. If you had invested $10,000 in equal amounts between the nine markets described in the previous chart over a 10-year period, the portfolio would have totaled $22,929.
On the other hand, trying to “time” the market by investing in the previous year's bestperforming market (in hopes it will continue), or worst-performing market (in hopes it will turn around), would have produced weaker results.
You can also see that investing a $10,000 portfolio in cash totaled $13,884 over the 10-year period. While a portfolio invested in cash is low risk, an investor should consider the effect of inflation, which has risen 3.86% on average each year.
Mutual funds provide a simple way to diversify your assets and spread the risk. By providing instant diversification through investing in a variety of different securities, mutual funds may help balance out overall performance and manage risk while working towards a specific investment objective. Further
10-Year Growth of $10,000 as of 12/31/07
This chart demonstrates the value generated by four different ways of investing $5,000 annually: buying the previous year's best-performing index, buying the previous year's worst-performing index, investing in a diverse portfolio and rebalancing annually, or investing in a diverse portfolio without rebalancing. The diverse portfolios are comprised of 25% large-cap stocks, 10% midcap stocks, 10% small-cap stocks, 20% foreign stocks, 10% REITs, 15% investment-grade bonds, 5% high-yield bonds, and 5% cash.
Past Performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes.
Sources: ChartSource, Standard & Poor's Financial Communications. For the period from 12/31/1997, through 12/31/2007. Large-cap stocks are represented by Standard & Poor's Composite Index of 500 Stocks, an unmanaged index that is generally considered representative of the U.S. stock market. Midcap stocks are represented by the S&P MidCap 400 index. Small-cap stocks are represented by a composite of the CRSP 6th-10th decile portfolios and the S&P SmallCap 600 index. Foreign stocks are represented by the Morgan Stanley Capital International Europe, Australasia, and Far East (EAFE®) index. REITs are represented by the NAREIT composite index of all publicly traded equity REITs. Investment grade bonds are represented by the Lehman Brothers U.S. Aggregate Bond index. High-yield bonds are represented by the Lehman Brothers High Yield Bond index.
Cash is represented by a composite of the yields of 3-month Treasury bills published by the Federal Reserve and the Lehman Brothers 3-Month Treasury Bills index. The diverse portfolio is for illustrative purposes only and does not represent a recommended asset allocation. Past performance is not a guarantee of future results.
The appropriate mix of investments depends on a number of factors. Your financial advisor can help determine what plan would be best for you based on factors such as:
Next Step: Determining a Suitable Asset Allocation Plan
Answer the four questions below to help you identify in broad terms what type of investor you are — conservative, moderate, moderately aggressive or aggressive. You can discuss the specifics with your Financial Adviser.
1.
When do you expect to begin taking money out of your investment plan? A) Within 5 years B) Within 6 to 10 years C) Within 11 to 15 years D) Within 15-plus years
2.
Do you have other money set aside to cover planned expenses (new car, home expenses,tuition payments) and emergencies? A) I have no separate savings. B) I will use part of the money for planned expenses. C) I don't anticipate having additional expenses. D) I have sufficient additional savings.
3.
Which of the following statements best describes your reaction if the value of your investments temporarily declines in value by 15%? For example, a $1,000 account balance drops to $850 in one day. A) I would be very uncomfortable and would withdraw my money immediately. B) I would be very uncomfortable and wouldn't add to that investment. C) I invest for the long term but would be concerned about a temporary decline in market value. D) I invest for the long term and can ignore temporary declines.
4.
Which of the following best describes your investment goals? A) I want my investments to be relatively safe from market declines regardless of growth potential. B) I prefer a mix of investments with an emphasis on low risk. C) I like a balance of low and high risk, with some chance for good potential returns. D) I would choose a mix of investments with higher risk, for potentially higher returns.
If more than 3 of your answers are “A” then a conservative portfolio is likely to be your best choice, especially if your investment time horizon is short.
If you are evenly split amongst “A” and “B” answers, then you may want to consider a moderate portfolio. Likewise, if you are evenly split amongst “C” and “D” answers, then you may want to consider a moderately aggressive portfolio.
If your answers are skewed to a “D” bias, an aggressive portfolio may be the best option for you.
Your Financial Adviser can help you to determine the best asset allocation for your portfolio
Balancing risk and reward is an essential part of investing. Of course, an investor can cut investment risk to virtually zero by owning only low-risk investments, like short-term Treasury bills or CDs.1 However, because you earn relatively little return on your money, it may be difficult to keep up with the rising cost of living.
And so ironically, by avoiding risk, you expose yourself to the very real, ongoing risk of seeing the value of your money diminish through Inflation has serious consequences to your financial future — particularly with respect to retirement. Take the soaring cost of health care. According to a study by Hewitt Associates, medical costs could consume about 20% of pre-retirement income for people who retire at age 65 and have no employer medical subsidy.
That's why you might consider a portfolio that includes a mix of low, medium and higher risk investments in a proportion based on your goals, your time horizon and your overall financial situation.
1 CD's, unlike mutual funds and other investments, are FDIC insured and offer fixed rates of return and stable principal.
2 Source: U.S. Bureau of Labor Statistics Consumer Price Index
While asset allocation is the key strategy to effectively managing investment risk, rebalancing is the dynamic tactic that keeps your portfolio true to the asset allocation model that has been established.
Consider a portfolio that consists of 60% stocks and 40% bonds. If the stock market rises, so may the stocks in the portfolio. As they appreciate in value, the overall allocation in stocks could rise to 70%, driving down the bond allocation to 30%.
When this occurs, the portfolio's risk/return characteristics change. To ensure that the overall allocation stays on track, the portfolio must be regularly rebalanced, which enables the investor to respond to changes in the market while remaining disciplined in the pursuit of their investment goals.
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