The single most important decision you will make in your investment life is how to allocate your assets.
Everyone Loves A Winner!
Diversification to an investor means spreading your money, and risk, over many types of investments. Everyone dreams of investing $10,000 in a stock like Cisco right after it goes public, riding that initial investment to millions of dollars then selling at the top near $80 in 2000 before Cisco went down to $15 in 2001. Of course, nobody in real life does this unless they are as lucky as the woman that wins the $50,000,000 state lottery.
If you bought Cisco back in 1990 or were dollar cost averaging into it all along, then the recent tumble from $85 to $15 would not be as traumatic compared to people recently buying at the top. Still, the fall from the top would not be pleasant.
If you knew ahead of time what stock would be a winner like Cisco, then investing would be easy. You would just buy the winners until they rang a bell and told you to sell!
Of course, the truth is for every Cisco there are many, many more companies that don't do well or even fail completely. One such stock is pets.com (Ticker=IPET) that went from $14 to zero in just under a year.
Diversification
The trick to successful investing for the long term is DIVERSIFICATION.
With good diversification, when stocks are going down, your fixed investments are actually going up due to the interest they earn. 5% money market return sure looks good compared to the 39% loss the NASDAQ market saw in 2000!
Asset Classifications
Assets are categorized in many classes:
- Equities: Stocks and Stock Mutual Funds
- Fixed Income: Bonds, Money Funds, Certificates of deposit and cash under a mattress
- Real Estate: Rental properties, land REITs, etc.
- Precious Metals: Gold, Silver, etc.
- Collectibles: Beanie Babies, Race Cars, Jewelry, art, etc.
Allocation by Age
The old rule of thumb was take your age and subtract it from 110 to get your percentage of assets in equities. Others say you can be 100% in equities up to age 40. I like having a bit of fixed, even while young, just to take advantage of market volatility.
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