How the right asset mix can lower your risk
Why mix assets?
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.
Short-term or "cash" investments are the calmest of all. Their value rarely changes from day to day.
Perhaps you gravitate toward one of these "personalities" more than others. But holding a mix of them may be the right solution for you.
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 may not lose as much.
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.
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.
A complete view of all the money in your account—i.e., not specific investments.
The investment returns you accumulate on the savings in your account.
What are the 3 most common 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 historical returns over time: 3.4% 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 historical returns over time: 5.3% 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 historical returns over time: 10.3% a year (for U.S. stocks).*
*All average return data covers the period from 1926–2019. For U.S. stock market returns, we use the Standard & Poor's 90 from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, through June 2, 2013; and the CRSP US Total Market Index thereafter.
For U.S. bond market returns, we use the S&P High Grade Corporate Index from 1926 through 1968, the Citigroup High Grade Index from 1969 through 1972, the Lehman Brothers U.S. Long Credit AA Index from 1973 through 1975, the Barclays U.S. Aggregate Bond Index from 1976 through 2009, and the Spliced Barclays U.S. Aggregate Float Adjusted Bond Index thereafter.
For U.S. short-term reserve returns, we use the Ibbotson 1-Month Treasury Bill Index from 1926 through 1977 and the Citigroup 3-Month Treasury Bill Index from 1978 through present.
Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Investments in bonds are subject to interest rate, credit, and inflation risk. Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.