How can you balance the quest for investment rewards against the potential risks? Part of this involves your personal comfort level and your investing timetable. Invest too conservatively early in your career or too aggressively late in life and you might fall short of your objectives.
But diversification is the chief tool of this balancing act. It can help you reduce the risks of your portfolio while still pursuing rewards by spreading out your investments over several kinds of assets—an approach that also may lessen the impact of the ups and downs of volatile markets. (Of course, diversification doesn't ensure a profit or guarantee protection against a loss, especially in a declining market.)
There are numerous ways to diversify within a portfolio, but you can build a basic framework on these four cornerstones:
1. Domestic stocks: Typically, this is the most aggressive part of a portfolio, likely providing the greatest potential for reward. Historically, stock market investments have outpaced most other kinds of holdings. Nevertheless, the market is volatile and periodically experiences downward spirals, so to take advantage of the potential long-term outperformance of stocks you have to stick to your plan over the long haul. It's the value of stocks when you decide to sell, not what they may be worth during the time you hold them that truly counts.
2. Domestic bonds: Bonds can serve as a counterweight to stocks because the prices of the two kinds of investments sometimes move in opposite directions. Again, there are no guarantees that this will happen or that holding both kinds of assets will have the desired effect. If safety is a primary concern, you might increase your investment in U.S. Treasury bonds or high-quality corporate bonds, which tend to offer less volatility, though with somewhat lower returns. In other cases, you might opt for high-yield bonds with their higher returns and greater exposure to risk.
3. Short-term investments: Conservative investments such as money market funds and certificates of deposit (CDs) generally offer stability and help preserve your principal. Most CDs are backed by the Federal Deposit Insurance Corporation within generous limits. A main attraction of money market funds, which aren't federally insured, is their liquidity, but you do risk losing principal.
4. International investments: Foreign holdings in stocks and bonds can round out a portfolio. With international stocks, both your potential returns and possible risks may be higher than they would be with domestic stocks. International bonds, too, offer the opportunity for more reward at a greater risk.