Diversification
You have an impressive selection of investments to choose from within today's complex financial markets. Although every investment carries risk, you can potentially manage your investment risk and enhance your chances of meeting your investment goals by practicing diversification through "asset allocation."
Asset Allocation
Asset Allocation is a sophisticated method of diversification which positions funds among major investment categories. This tool can be used in the effort to manage risk and enhance returns, although it does not guarantee a profit or protect against loss.
In other words, asset allocation refers to the way in which you weight diverse investments in your portfolio in order to try to meet a specific objective.
For instance, if your goal is to pursue growth (and you're willing to take on market risk in order to do so), you may decide to place 20% of your assets in bonds and 80% in stocks.
The asset classes you choose, and how you weight your investment in each, will probably hinge on your investment time frame and how that matches with the risk and reward potential of each asset class.
Points to Remember
- Asset allocation is the way in which you spread your investment portfolio among different asset classes, such as stocks, bonds and money market securities.
- When prices of different types of assets do not move in tandem, combining these investments in a portfolio may help manage the variability of "market risks.".
- The asset allocation that is right for you depends on your investment time frame, goals, and tolerance for risk.
- As your investment time frame and goals change, so might your asset allocation. Many financial experts suggest re-evaluating your asset allocation periodically or whenever you experience a milestone event in your life such as marriage, the birth of a child, or retirement. Be sure to check with your Financial Advisor for an evaluation of your own portfolio.
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Dollar-Cost Averaging
A Common Sense Investment Strategy
If the stock market's gyrations give you the jitters, you're not alone. However, there is a way to have the ups and downs of the stock market potentially work to your advantage. It's a surprisingly simple strategy called dollar-cost averaging. In fact, if you are participating in your employer's retirement savings plan, you are using dollar-cost averaging.*
How It Works
Dollar-cost averaging is nothing more than the regular purchase of securities in equal dollar amounts over an extended period. You put in the same fixed amount of money every pay period, regardless of the price. The potential results of sticking with such a plan can be startling. The reason is that your fixed amount of money buys more shares when the price is low and fewer shares when the price is high. This may bring down the average cost. Usually over long periods of time, the average cost of all the shares you bought will be lower than the average share price.
Periodic investment plans do not assure a profit or protect against loss in declining markets. This type of strategy involves continuous investments in securities regardless of fluctuating price levels. Investors should consider their financial ability to continue purchases through periods of low price levels.
Source: ChartSource, Standard & Poor's Published Image. More Room for Growth
To be sure, dollar-cost averaging does not guarantee a profit or protect you from loss in a declining market. It does, however, free you from worrying about trying to time the market, something even the experts fail to do consistently. And it generally provides a lower average cost.
Timing the Market: Be Careful
If you've ever been tempted to play the stock market with your retirement savings plan, here's some advice: Don't. Nor should you shift funds from one account to another simply because one showed higher returns on your latest plan statement. Here's why:
- Market Shifts Can Be Sudden and Dramatic Over Short Periods
Minor shifts are a fact of life in the stock market. And major changes sometimes come swiftly. Stocks are traded in markets that are highly charged with a mixture of fear and greed. Major news developments can cause sudden reversals and large moves up or down can be compressed into brief periods.
- You May Be Shooting at Where the Rabbit Was
A common tendency is to switch into the investment option that performed best last quarter or last year. Acting on historical data is risky because past performance is seldom a reliable indicator of future performance. Last quarter's hot investment may cool in the next quarter. Besides, if you're acting on fund performance data reported in your benefits statement, remember that the data is probably at least a few weeks old.
What Should You Do?
Your best bet is to select a combination of options that suits your own situation - your age, when you expect to retire, your ability to sleep when markets are in turmoil.
- If you're young, for example, you can generally afford more risk and may emphasize stocks in your allocation. History is on your side.
- On the other hand, as you approach retirement you may emphasize "safer" investments, typically a fixed-income option. The closer you are to retirement, the more disastrous a knee-jerk investment decision turned sour can be for you.
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My Retirement
Even when you do all of the right things in preparation for retirement, once you’re there, the money decisions made are just as important as all of the time you spent preparing. Are your needs in-line with your means for a comfortable retirement? This question must be asked frequently in retirement to make adjustments for life’s little changes.
Now that you’re retired, it’s time to re-evaluate your financial future again. There can be many life changes that impact your retirement savings. Perhaps an unexpected source of income or additional expenses may occur. Maybe marital status or ideas about where to spend the money while in retirement will change. Identifying these changes and understanding the tax-implications will help you through this important time in life.
While discussing the financial status with your Financial Advisor there is one important question to keep in mind. Does your risk tolerance and current investments match your financial goals?
Not only do you need to look at current investments, knowing which assets should be used first can have an impact on the decisions you make. Some decisions may be easier than others. When considering Social Security, age and work status (full or part-time) may affect benefits and may have tax implications.
Once the Social Security impact is evaluated, investments can be addressed. Were the investments made with pre-tax or after-tax dollars? With after-tax dollars that do not grow on a tax deferred basis, perhaps these funds should be used first. If your income is higher now than it might be later, realizing long term capital gains may make sense. Long term capital gains are taxed at a lower rate than ordinary income, so for individuals with higher incomes, this may be the best way to start. This way, any funds in a tax-favored account can potentially grow tax-deferred until such funds are needed.
Remember, when you are over age 59 ½, distributions from a Roth IRA won’t trigger taxes as long as you have owned a Roth IRA for at least five tax years. Unlike 401(K) plans or traditional IRAs, Roth IRAs do not require distributions by a specified age during the owner’s lifetime. This allows you to reserve these dollars for later use or may be a tax-efficient way to leave money for loved ones. Contact your Financial Advisor and discuss your options!
You should always consult a competent tax advisor regarding the tax implications of any product, or any use of a product in your particular situation.
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