Picking the Right Investment to Protect Your Portfolio
A:†††††††† Welcome to Your Money, the podcast about wise investing.† Today weíre going to talk about asset allocation.†
B:†††††††† Asset what?
A:†††††††† Asset allocation.† Thatís just a fancy name for dividing your investments among different asset categories.
B:†††††††† Whatís an asset category?
A:†††††††† The biggest asset categories are stocks, bonds, and cash-like instruments like CDs and Treasury bonds.
B:†††††††† Why would I want to divide up my investments between stocks, bonds and cash-like instruments?
A:†††††††† Because historically, the returns of those three categories have not moved up and down at the same time.† By investing in assets with investment returns that move up and down under different market conditions, you can protect against significant losses.
B:†††††††† I like the sound of those words - protection against losses.† I hate losing money.† But how does it work?
A:†††††††† If you put all your financial eggs in one basket, and that basket drops in value, your entire investment portfolio drops.† But if you spread out your investments and diversify, you donít lose everything even if one of your investments craters.†
B:†††††††† You mentioned dividing up investments among different asset categories like stocks, bonds and cash-like instruments.† I bet that for the part of my money that Iíve got in the stock market, itís more risky to stick all my money in just one stock, right?
A:†††††††† Right.† If youíre buying stock, you can reduce your risk of losing money by owning stock in lots of different companies, instead of just one.
B:†††††††† Thereís a company I like - GrowthVenture.† I got an e-mail about it.† The e-mail said the stock price has tripled recently.† I went to the website, GrowthVenture.com, and found they have a new huge contract with the government.† Youíre saying that if I put all my money in the stock of GrowthVenture, itís more risky than buying stock in a wide variety of companies?
A:†††††††† Exactly.† If you only own one hot stock and it goes down in value, it will take down your entire investment.† But if you own a selection of stocks and one tanks it wonít take down your entire account value.† And if you invest in several asset categories Ė stocks, bonds and cash-like instruments, youíre more protected than if you have put all your money in just stock.†
B:†††††††† Youíre not saying that diversifying will guarantee that my investments wonít drop in value, right?†
A:†††††††† Of course not!† There are no guarantees in life.† But diversification can improve the chances that you wonít lose money Ė or that if you do, you wonít lose as much as if you hadnít diversified.
B:†††††††† So how do I figure out which are the best investments for me?
A:†††††††† That is a very personal decision. The answer depends on when you will need the money, your goals, and if you will be able to sleep at night if you purchase a risky investment where you could lose money.† And the answer will be different for you at different points in your life.
B:†††††††† Why?† Why would I have to think about changing investments, once I have it figured out?
A:†††††††† Because your time horizon is really important to your asset allocation.†
B:†††††††† Time horizon for what?
A:†††††††† For reaching your savings goal.† If you are 20-something and saving for retirement, youíve got a long time horizon, and you might feel more comfortable taking on riskier investments because you have more time.† Youíve got the time to wait out slow economic cycles and the short term ups and downs of our markets.
B:†††††††† Plus, if I put all my retirement money in a savings account for 40 years, my money might not grow as fast as inflation, and I might not save enough to retire!
A:†††††††† Thatís true.† Now, for savings goals where you have a shorter time horizon, youíll probably want to take on less risk. †
B:†††††††† Iíve got several savings goals.† Iím putting away as much as I can for my retirement, but Iím also saving for a down payment on a house in 2 years, so Iíve got a pretty short time horizon on that goal.†
A:†††††††† Exactly.† And cash investments may be most appropriate for short-term financial goals.† The fact that stock prices can go up and down a lot in the short term makes them a very risky investment for short term savings goals Ė like your house down payment in 2 years. †
B:†††††††† Sounds great!† Now, can we talk about how to pick investments for my retirement account?†
A:†††††††† Thatís a topic for another podcast.† Stay tuned for more episodes.† And thanks for joining us.† Your Money is brought to you by the U.S. Securities and Exchange Commission.† Write us at firstname.lastname@example.org