Choosing an Asset Allocation Fund to Suit You

A mutual fund classified as an asset allocation fund has a variety of types of assets in it, spreading your risk among them. The goal is to reduce your chance of loss, or increase your chance of gain depending on your personal investment preferences. Choosing an asset allocation fund requires that you understand what such a fund is, the basics of the three asset classes and how your preferences should direct you.

Asset Allocation Fund Defined

A simple definition of an asset allocation fund is a mutual fund that contains assets from the three major asset classes: stocks, bonds and cash. A mutual fund is a pool of money from many investors managed by an investment professional. Many mutual funds focus on one area. For example, a mutual fund might be only for large capitalization stocks, foreign growth stocks or bonds. Every fund has a stated investment philosophy like that. An asset allocation fund invests across asset classes.

A Look at the Asset Classes

The three primary asset classes are stocks, bonds and cash.

  • Stocks - This is ownership in a company. Stocks are equity investments and considered to have the highest risk. However, historically there has been the highest chance of return as well.

  • Bonds - Bonds are long-term debt that a company sells to investors. Excepting high-yield, or “junk” bonds, bonds are considered to be less volatile than stocks. Of course, less risk typically equals less return.

  • Cash - As it sounds, this is money or its equivalent, like a certificate of deposit. Risk is the lowest among asset classes as is return, but inflation can pose a risk as well.

Inside an Asset Allocation Fund

There are different varieties of asset allocation funds. Some are heavily focused on stocks, some toward bonds and some are cash heavy. An allocation fund will continually re-balance themselves stocks and tend to grow more quickly. The same can happen in reverse, or in a down market, where stocks lose value and bonds rise as a percentage of the value of the asset allocation fund.

Your Personal Tolerances

In general, two key elements will point you to the type of asset allocation fund for you:

  • Risk Tolerance - The value of your investments will go up and down. Some people don’t like watching the swing in value. Their tolerance for such risk is low. Others don’t mind, assuming the market will move higher over time as it has in the past.

  • Time Horizon - Risk tolerance is a personal decision. But time is fixed. Typically, if you have a long-term horizon you can afford more risk. If you need your money in the short-term, you avoid risk.

Picking Your Fund

Choosing an asset allocation is a matter of adjusting your financial goal to the time you have and the risk you can tolerate. Since the amount of time is what it is, the first step is estimate how close you can get to your goals in the time you have with the risk you are comfortable with. Once you have this in balance, pick a fund whose asset classes match with your risk and growth goals.

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