business Personal FinanceWall Street 101

Introduction | Tips For Getting Diversified | Appropriate Diversification | Maximum Portfolio | Investments That Reduce Risk | Assest Class Mixes

Diversify

How Asset Mixes Influence Your Total Return

Under Modern Portfolio Theory, the critical first step to developing a suitable investment account is deciding which asset types you want to buy, and not which individual stocks and bonds.

Investing into many different asset classes makes more sense than worrying about whether a particular security is in itself "safe enough." Even the riskiest securities, like junk bonds and derivatives, can add value to a low-risk portfolio if they are used in the proper proportion. The impact of a security on the total portfolio is the paramount concern.

So if you want to get a higher return for the same risk, or reduce your level of risk for the same expected return -- in other words, make your portfolio more efficient -- you would be smart to consider investing in the full spectrum of "safe" and "risky" asset classes, from money market funds to small cap stocks.

If, for example, you want to improve the efficiency of an all-bond portfolio, you could either reduce risk or increase potential return. You could try to achieve this goal by adding bonds with varying maturity dates and interest rates to your portfolio, but it's far more likely that you'll get what you want by taking on some stocks and cash instruments.

The important thing to know about asset allocation is that asset classes work together to produce a desirable portfolio. Each asset class will add something. Trying to build an account with only one type of asset is like trying to clap with only one hand.


The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
Copyright © 1996 - 2000 mPower. All Rights Reserved.