Asset allocation is the process of
investing money in a variety of securities to match your risk tolerance
with a diversified portfolio that will best meet your goals.
This section highlights the basic classification of assets so that you can
better understand what kinds of investments fall into each of the
categories.
Growth or Stock
Investments
Small Cap Stocks
Stock in companies that have a market capitalization of
less than $1 billion. These companies tend to be more volatile than
the normal stock since they historically have been the most susceptible to
bankruptcies and have more unpredictable earnings. Since these
stocks behave differently than larger companies, it is generally accepted
to compare a small cap investment against a small cap index, like the
Russell 2000, instead of comparing it to a large company index like the
S&P or Dow.
Mid Cap Stocks
Stock in companies that are in between $1 billion and $30
billion (definition may vary) in size. These stocks tend to be more
volatile than large cap stocks, but less volatile than small cap and
international equities.
Large Cap Stocks
Stock in very large companies with market capitalizations
above $30 billion in size. These stocks are generally more
established and tend to have fairly consistent earnings growth, which
makes them less volatile than other forms of stock. Large cap
equities are still risky investments compared to fixed income and cash
investments.
Stock in companies that conduct a majority of their
business in foreign countries. Since stock in foreign countries have
the currency exchange risk in addition to standard risks associated with
equity investments in a less stable economy, international investments are
generally considered more risky than domestic investments. This is
ultimately dependant on the countries in which the company does business,
the geopolitical environment of those countries and various other factors.
Fixed Income or Bond
Investments
Short Term Bonds
This can include CDs, Treasury Bills, or Commercial Paper
with maturities under one year. Since the life of the bond is so
short, they are relatively safe, but also have lower yields than other
bonds with longer maturities. Certain cash equivalents may also be
considered Short Term Bond investments.
Bonds with maturities of between one and five years.
These bonds generally yield higher coupons with their longer
maturities. The yield of the bond will also depend on other factors,
such as the credit worthiness of the borrower.
Long Term Bonds
These bonds tend to be anywhere from five to thirty years
in life. The longer maturity the bond is the higher chance there is
of default. This higher risk usually means that the bonds pay a
higher coupon as well to compensate the bond holder for accepting that
risk. Even with this higher risk, bonds in general tend to be less
volatile than equity investments.
High Yield Bonds
These bonds are typically issued by corporations that are
at a relatively higher risk of defaulting than other bond issues. This higher risk usually means that the bonds pay a
higher coupon as well to compensate the bond holder for accepting that
risk. The bonds can be of varying maturities and are generally
compared against higher quality bonds to determine if the risk is worth
the added reward in interest.
Cash
Cash and Cash Equivalents
This can include money markets and certain income
investments that may be maturing within the next three months.
Obviously, this is the less risky investment a person can own, but also
yield the least in terms of return.
Securities are not guaranteed and can
lose value. Losses, as well as gains, may occur when investing in
marketable securities. Talk with a financial consultant for more
information.
