As a Certified Financial Planning Professional (CFP), people ask me how they should invest for retirement. Their next questions often focus on what investment is best right now, and how they can get into the “Next Big Thing.” The focus on an individual investment misses the mark, though. It’s more important to start early and have a long-term financial plan. As we age, most people find that their goals change from when they were young. Financial growth over everything else is no longer as important. Even before the transition to retirement income begins, retirement planning requires a reconsideration of the risk level in your portfolio and often a reduction of its market volatility. The planning doesn’t end when you retire; you will need a retirement distribution plan. How you withdraw your money is just as important as how it should be invested. That way your investment assets can give you the lifestyle you want to live long after you end your career.
One of the most effective ways to reduce risk is to increase the diversification of your investments. How to do this is often misunderstood. Owning 10 different growth stocks does not mean one is diversified. A diversified portfolio uses many different asset classes and a wide variety of investments in each Asset Class.
1. What Are Asset Classes, Correlation, And Allocation?
An asset class consists of investments that are similar in structure and share risk characteristics. The investments in an Asset Class tend to act the same over the long term, although individual investments can wildly out-perform the group or fail fantastically. The broadest way of looking at this is
- Stocks, which are partial ownership in a corporation
- Bonds, which represent the debt of a company or government
There are alternative assets, like real estate, precious metals, and commodities. Each of these broad classes can be broken down into smaller and smaller groups of investments. From the U.S. viewpoint, we can first think of domestic and foreign stocks. Then…
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