How the right asset mix can lower your risk
Mixing different types of assets can cushion you from big swings in your account balance and lower your overall risk.
Each kind of asset has its own personality
Stocks tend toward the dramatic—they can be way up one day and way down the next. Anything from economic reports to marketplace rumors to natural disasters can sway them.
Bonds are more sedate. Their prices aren't as likely to experience swings in direction from day to day, and their ups and downs tend to be less exhilarating than those of stocks.
Cash investments are the calmest of all. Their value barely changes from day to day.
Perhaps you gravitate toward one of these "personalities" more than others. But holding a mix of them can be the best solution of all.
By mixing different types of investments together, you lower the overall risk in your portfolio, since different types of assets usually perform differently at any one time. This doesn't mean you can't lose money; it just means that you're better protected.
It also gives your account balance the opportunity to grow at a rate higher than you'd see with an all-cash portfolio, but in a more stable manner than you'd experience with an all-stock portfolio.
What are the 3 asset types?
Cash (short-term reserves)
Main goal: keeping a stable value. You probably won't lose money with these investments, but you won't gain much either.
Main risk: The rate at which you earn money could be lower than the rate of inflation.
Average return over time: 3.5% a year.
Main goals: gaining a moderate amount of earnings in exchange for a moderate amount of risk; offsetting the larger risk of stock investments.
Bonds can be domestic (from the United States) or international. Having both in your portfolio helps spread out your risk even more.
Main risks: Rising interest rates could push bond prices down, and the bond's issuer could default.
Average return over time: 5.5% a year (for U.S. bonds).
Main goal: gaining larger earnings in exchange for a larger amount of risk.
Stocks can also be domestic or international, and as with bonds, it's smart to consider holding both.
Main risks: Stock prices could drop for a variety of reasons, including poor performance of certain companies and broad concern about the economy. Downturns in the stock market tend to be worse than downturns in the bond market.
Average return over time: 10.2% a year (for U.S. stocks).
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Choose investments for your goal
Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.
The investment returns you accumulate on the savings in your account.