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Investing in the right mixture of investments is extremely important. Asset allocation is a process for splitting your money among different types of assets such as stocks, bonds and cash. This investment strategy is based on the assumption that various investments will do well at different times. Asset allocation is based upon your financial objectives, age and risk tolerance.
If you’re just getting started, you probably have very little money invested, so asset allocation isn’t an issue. As your money grows, however, it’s important that you diversify your assets, so you’re not depending on one or two investments to build your fortune.
There’s a rule of thumb that suggests how much of your assets should be in stock. You subtract your age from the number 100. The result is the percentage of your assets that should be invested in the stock market.
For example, a 25-year-old should consider having 75 percent of his or her assets in the stock market, since 100 minus 25 equals 75. On the other hand, a 70-year-old might want to limit his or her stock holdings to 30 percent, the figure you get after subtracting 70 from 100.
You should diversify further within each asset class. For instance, you might further diversify your stock portfolio with growth stocks, value stocks, mutual funds, and index funds. Index funds invest in securities that make up an index like the S&P 500 or the Dow Jones Industrial Average.
The key to asset allocation is that you must rebalance your portfolio periodically. For example, if the stocks in your portfolio have increased in value by a substantial amount and you now have too much money tied up in the stock market, you should rebalance and add to your other investments.
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