Chicago. The tenet of asset allocation is to identify a mix of different types of investments with the highest potential return for your level of risk tolerance, consistent with your goals and the time frame in which you have to reach them.
It’s very simple to pick out the “hot” investments—those that have performed very well over a short period of time. Let’s consider an example of someone who keeps a fair amount of money in a cash position. Each time she receives recommendations, she says that she would like to think about it before acting. She then calls and says she has picked out a few funds on her own. As a financial advisor, I pick mutual funds based upon past performance over 10 or more years. I look at track records, fund managers, and the makeup of the funds. This woman, though, only looks at 1-year returns. Even though she knows better, she continues to chase returns. Purchasing funds at their 52-week high isn’t the smartest reason to invest in a particular mutual fund. This is something I caution all my clients against.
What isn’t so easy is to pick the proper mix of investments that will perform well over a long period of time because investments fluctuate throughout various market conditions. Purchasing mutual funds because they are at, or near, their 52-week highs is not a good reason to buy. The key to successful investing is to recognize that no single investment will provide consistent, high returns that will allow you to reach your financial goals. By diversifying through different types of investments through asset allocation, you increase your chances of long-term, positive portfolio increases. (See Figure 2.1.) It’s important to have your investment dollars spread across many investment vehicles to help protect your money against the perfor- mance of one single investment.
Different investments provide different levels of returns. For example, some stock prices tend to rise and fall with the economy, while the values of variable fixed-income securities generally change with the interest rate. Then there are investments that strictly earn interest and are not subject to the ebbs and flows of the stock market or the interest rate. Even though separate forces may affect different investments, the change in one may trigger a pre- dictable movement by another. While asset allocation doesn’t