Asset allocation is the all-important decision of how to allocate your investment assets between stocks and bonds—between high risk and low risk investments. This page will help you learn the basics about asset allocation. Contents:
Select Video Tutorials about Asset Allocation
Playlist for Asset Allocation:
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All are excellent videos. The transcripts can help you make best use of your time.
Commonly asked questions about Asset Allocation
- 1.1 Why invest in bonds?
- 1.2 How to use bonds to reduce stock market risk?
- 1.3 Are bonds a safe investment?
- 1.4 Why are bonds an attractive way to diversify?
Quick answers to common questions about asset allocation
Why invest in bonds?
Main article: Why Bonds? #1 — Stocks Are Risky (video)
Stocks have historically outperformed bonds. So why bother investing in bonds? The answer is because the stock market is so risky. Stocks can lose 50% of their value, or more, in any year. Bonds are risky too, but far less so! Bonds anchor part of your investments. High quality bonds can be chosen for safety. The amount of your portfolio exposed to stock market risk should be very deliberately limited to your circumstances.
How to use bonds to reduce stock market risk?
Main article: Why Bonds? #2 — Bonds Make Risk Palatable (video)
Too often investors are attracted to stocks in a bull market and invest too much in this volatile asset. How much is too much? Well, it is clearly too much if it a falling (bear) market causes the investor to sell. Much is lost by investors selling late and then buying late. A wise investor keeps this stocks/bonds ratio under control by rebalancing when the actual changes from the desired ratio by more than a few percent. Otherwise, all investments are for the long-term and investors stay in the market come hell or high water. The bond portion of an investment portfolio makes stock market risk more palatable.
Are bonds a safe investment?
Main article: Why Bonds? #3 — Bonds Are Safe Bet (video)
There is no safer investment than U.S. Treasury bonds, or bonds (or CDs) guaranteed by the U.S. government. Period.
That said, the value of a bond changes everyday with interest rates—they are related by simple arithmetic. The value of long-term bonds change more than short-term bonds so investors control this. Choosing high quality bonds with a duration that matches your cash flow needs make bonds perfect for the portion of your portfolio that needs short-term safety.
Why are bonds an attractive way to diversify?
Main article: Why Bonds? #4 — For Attractive Diversity (video)
Stocks are not 100% correlated with each other, but many of them move in the same direction at the same time. High-quality bonds, on the other hand, are nearly uncorrelated with stocks. Whenever you can add an uncorrelated security to your portfolio, the resulting portfolio will have a greater return for a given level of risk. There is some evidence that TIPS, Treasury Inflation Protected Securities, are even slightly negatively correlated with stocks—meaning that when observed over long periods of time they tend to move in the opposite direction as stock prices. This is very rare and valuable for reducing the portfolio volatility.