In order to minimize risks and even improve your chances of gains, you have to allocate your investments among different asset classes. The first step in doing this is to understand how asset allocation works. There are different kinds of portfolio models that say something about your preferences.
Asset Allocation Defined
Asset allocation refers to the strategy of dividing your investment portfolio across various asset classes such as stocks, bonds, and money market securities. Basically, asset allocation is an organized and effective method of diversifying your holdings in the portfolio.
Your choices usually consist of three asset classes, which are stocks, bonds, and cash. Within these assets, you got a plethora of choices in terms of sub-classes or alternatives, including:
- Large-cap stocks
- Mid-cap stock
- Small-cap stocks
- International securities
- Emerging markets
- Fixed income markets
- Money markets
- Real estate investment trusts (REITs)
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Conservative Portfolio
Conservative model portfolios are those that generally allocate a large percent of the total portfolio to lower-risk assets such fixed-income and money market security.
The main goal of a conservative portfolio is to guard the principal value of your portfolio (the money that you have originally invested). And because of that, these portfolios are also referred to as “capital preservation portfolio).
If you are conservative and you prefer to avoid the stock market completely, some exposure can also help offset inflation. You can expose the some portfolio portion in high-quality blue chip companies or an index fund, since main goal is not to outperform the market.
Moderately Conservative Portfolios
As the name suggest, the moderately conservative portfolios is good for those that wish to preserve a large slice of the portfolio’s total value, but are quite willing to take on a higher amount of risk to get some protection from inflation.
A strategy commonly used for this risk level is called “current income,” in which you choose securities that pay a high level of dividends or coupon payments.
Moderately Aggressive Portfolios
The moderately aggressive portfolio model is usually called balanced portfolio since the asset composition is divided nearly equally between fixed income securities and equities in order to provide a balance of growth and income.
Since moderately aggressive portfolios have a higher level of risk than conservative portfolio, this strategy is ideal for those who have a longer time horizon, which is generally longer than five years, and medium level of risk tolerance.
Aggressive Portfolios
Aggressive portfolios is mainly composed of equities, so their value tends to fluctuate, you main goal is to acquire long-term growth of capital. And because of that, the strategy of an aggressive portfolio is usually referred to as the “capital growth” strategy.
To offer some diversification, investors with aggressive portfolios typically add some fixed income securities.
Very Aggressive Portfolios
The very aggressive portfolio sports nearly all equities. And because of that, with a very aggressive portfolio, the main goal is to achieve aggressive and fast capital growth over a longer time horizon. And because these portfolios carry a huge amount of risk, the value of the portfolio will differ widely in the short term.
