1. What is asset allocation?
All investors must determine how they should divide their cash. Putting more money in fixed income than stocks, or in Canada versus overseas, will have an impact on both risk and reward. It's a good idea to talk to an adviser if you're not sure how much risk you want to take on. Asset allocation is exactly what you think it is -- it's determining where you allocate the money in your portfolio.
2. Why is asset allocation important?
The primary reason you need to seriously consider your asset mix is because of the importance of diversification. Generally, the more diversified your investments are, the less risk to your savings. If you only invest in one sector, or one type of security, your investments are more volatile and you have a greater risk of big losses.
3. What are the main asset classes?
Assets are typically divided into three classes: stocks, bonds and cash. Stocks are shares of companies that trade on a stock market; bonds are shares of debt issued by a company that pay interest; cash is, well, cash.
Some people consider real estate -- literally, property -- and commodities (oil, gold, cotton, etc.) asset classes as well. On the risk scale, stocks are the most volatile, bonds are less risky and cash, which just sits in a bank account, is the safest in terms of preserving your principal.
4. How do we choose investments?
Part of this process is also choosing what types of investment you want to own: for instance, options could include mutual funds, exchange-traded funds, stocks or bonds. You might want a few mutual funds and a couple of ETFs, or all stocks. Balanced mutual funds own some stock and some bonds, so the asset mix is predetermined. Or you can choose your own adventure and buy 70 per cent stocks and 30 per cent bond funds. Your choices depend on your risk tolerance and, partly, whether you want to leave your assets with a manager or invest yourself.
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