Friday, July 13, 2012

How to Make an Investment Portfolio More Conservative With Asset Allocation

Your individual goals and financial capabilities influence your decisions regarding proper management of your investments. If you believe the stock market is poised for unacceptable declines and want to shield your portfolio from potential economic downturns, a shift to more conservative assets may suit you.

Similarly, as you approach the date when you expect to begin withdrawing money from your investment account, you may want to reduce your portfolio risk to better secure any gains you have earned. Fidelity Investments explains, "How you determine your asset allocation largely depends on your comfort with risk and the time frame for your investments."

Asset Allocation


Multiple factors must be considered when building a proper investment portfolio. Your current and anticipated financial resources, goals, risk tolerance and time horizon should all play a role in determining what constitutes a suitable portfolio.

The U.S. Securities and Exchange Commission states that, "By investing in more than one asset category, you'll reduce the risk that you'll lose money and your portfolio's overall investment returns will have a smoother ride."

Several allocation models exist to guide you in selecting appropriate investment types and determining how much of your portfolio should be dedicated to each. Investing money in conservative vehicles and eliminating inappropriately aggressive ones, in addition to including less volatile asset types, can make your portfolio more conservative.

Risk Tolerance


Your portfolio's composition should be largely based on your risk tolerance, which is your personal comfort level and threshold for volatility. Risk tolerance profiles are used by investment professionals to determine a starting point for creating appropriate portfolios for clients and are largely tied to generic allocation models.

While industry standards depict average and expected risk tolerance levels for each age group and consumer category, your own comfort level may not fall within those boundaries. Just because your peer group typically chooses one particular allocation model does not mean you must follow suit.

Security Types


If you think your investment portfolio is too aggressive, shifting a portion of your money into less volatile securities can reduce your exposure to market shifts. Avoid or eliminate "small cap" stocks, shares of newer or less established companies, and instead opt for "blue chip" stocks, shares of older, more stable companies with consistent performance.

Buying bonds will also make your portfolio more conservative because their value is unaffected by the factors that influence stock prices. Russell Investments explains, "An important distinction when weighing the rewards of stocks vs. bonds is that stocks have (theoretically) an unlimited ability for appreciation," whereas "a bond buyer generally knows the upper limit to expect on such an investment."

Rebalancing


As the value of your investments reacts to changes in the market, the percentage of your portfolio represented by each security will fluctuate. For example, an initially moderate portfolio may no longer meet the definition as such if the stock holdings dramatically increase in value and the bonds sharply decrease.

The portion of your portfolio representing each investment type should be examined regularly to ensure your account does not begin to reflect an unsuitable risk tolerance. When necessary, you can make your portfolio more conservative by selling a portion of the equities and purchasing less aggressive bonds, returning your asset allocation to its original state.

Bankrate.com explains, "Once your investment pie is meted out into individual slices and money is poured into investments, sticking within the planned proportions becomes the maintenance work."

References


Bankrate.com: How to Build a Sound Portfolio

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