After you have a good start on paying down credit card debt, and the beginnings of an emergency fund set up, then you can get started on their investments. In order to get the most out of your investments, you should strive to maintain proper asset allocation. Staying properly allocated, and rebalancing regularly, will help to not only increase your rate of return, but also lower the amount of risk you take. Choosing to spread your investments out over a variety of places, rather than just one asset class, will help ease the volatility in your account.
Many financial professionals agree that there are 9 asset classes a person can invest in. Utilizing all of them is the most beneficial to a portfolio.
Large Cap – Domestic and Foreign
A company where the total value of all their outstanding shares of stock are valued at over $10 billion (some analysts say $5 billion) is considered large cap (large market capitalization). These companies are seen as stable, and will post regular earnings. They have a developed business plan that is tried and true. Domestic companies are domiciled in the United States; foreign companies are outside our borders. Walmart (WMT), General Electric (GE), and Kraft Foods (KFT) are some examples of large cap companies.
Mid Cap – Domestic and Foreign
Companies that have a middle of the road market capitalization (between $2 and $10 billion) are considered mid cap. These companies are often just as sound as their larger counterparts, but they have not had the time to grow to become large cap. Subsequently they carry a little more risk, and as a trade-off a little more return on investment. Many mid cap companies perform a vital role in society, but often people do not recognize their name.
Small Cap – Domestic and Foreign
It is often said that small business is the backbone of the economy. Businesses that grow to be slightly larger than that fall into the small cap category. They do not have the well developed business models, and often are seen as risky investments. The good news is that when they take off, they provide substantial returns to their investors.
Real Estate
Rather than go out and purchase real estate directly, people can invest in REITs. These specialized securities allow the investor to capitalize on the gains that are found in real estate without having to take ownership of physical property.
Fixed Income
A fancy word for bonds is fixed income. Stocks and bonds have an inverse correlation. That means when stocks are doing great, bonds are often doing poorly, and vice-versa. Many investors who are getting closer to retirement would be best served to have a large portion of fixed income in their portfolio.
Commodities
An often neglected asset class, commodities make up an important part of a portfolio. While most people want precious metals, there are many other types of commodity investments such as energy, foods, and dry goods. Commodities are important because they provide a stable return despite what the market may be doing.
Using a risk profile, you can accurately determine what mix of assets you should be invested in. This asset allocation will help to diversify, minimizing asset risk. At least once per year your allocation should be reviewed, and rebalanced as necessary since some investments will grow faster than others. Maintaining proper allocation will help any investor make the most of their money, and give you a plan that helps deter emotional decisions.
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I’m a big fan of small cap stocks. They are a little riskier but over a long period of time they prove to outearn their larger counterparts. I’m often shocked at how many people fail to invest in small cap funds and emerging market funds.
Nice beginner’s guide to asset allocation. It’s funny how many people have heard the term but how few know what it actually means.