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Asset Allocation: Getting It Right

Did you know that having the right mix of investments is one of the most important factors in determining your investing success?

The investments in your plan generally fall into one of three basic asset classes: short-term reserves, bonds, and stocks. How you divide your money among these investments is known as asset allocation. The key to asset allocation is finding an investment mix that fits your financial goals, time frame, and comfort level with risk.

Risk Versus Reward

When deciding how much risk you can handle, consider the length of time you have to invest. The longer you have to invest, the more risk you may want to consider, because you have more time to ride out short-term market losses in hopes of greater long-term returns.

By mixing different types of investments, you can come up with the combination of risk and potential return that's right for you.

Here's a look at the asset classes and their risks.

Asset Classes Risks
Short-term reserves seek to preserve your original investment and pay you interest over short periods of time. Simply, you put in $1 and get back $1, plus interest. Short-term reserves appear to be a no-risk option because they aim to maintain a steady value. But many people overlook their hidden risk: inflation. The rise in the cost of living can outpace the returns you receive from so-called “safe” investments.
Bonds are loans to a company, a government, or a government agency. When you buy a bond, the issuer of the bond—either a company or government—agrees to pay back your original investment, plus make regular interest payments along the way. Bonds move up or down in value with changes in the economy and interest rates. The longer the term of a bond, the more sensitive it is to these changes.
Stocks represent ownership in a company. When you own stock, you can make money if the company does well and its stock price goes up. Some companies also pay dividends to those who own their stock. Stocks can be very volatile. A stock that rises steadily in value one week can fall sharply a week later. Stocks offer the highest potential returns over time, but they also pose the highest risk to your original investment.


Need Help With Your Investment Strategy?

Complete Vanguard's Investor Questionnaire. The questionnaire will lead you to a suggested investment mix based on your risk tolerance, goals, and time frame. It's available online at www.vanguard.com, or by calling Vanguard® Participant Services at 1-800-523-1188.

©2007 The Vanguard Group, Inc. All rights reserved. Used with permission.


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