If the Enron and WorldCom scandals have taught investors anything, it is that betting your future solely on one company's stock is a huge mistake.
In fact, talk to any financial adviser and the mantra these days is diversify, diversify, diversify. But to average investors, that's not so simple. What exactly does that mean and how do they go about doing it?
Asset allocation means spreading out your money across different asset classes (such as stocks, bonds and cash) and within each asset class (not buying just one type of stock, bond or mutual fund). The idea is that when one asset class falls, another may rise, which cushions the portfolio.
"At minimum, a moderate investor would probably want to hold five asset classes: large-capitalization stocks, small-capitalization stocks, international stocks, bonds and cash," said Roger Ibbotson, chairman and founder of the asset allocation firm Ibbotson Associates and finance professor at the Yale School of Management.
But diversification is not always easy or cheap. About 75 percent of mutual funds have minimum investment requirements of $1,000 or more, according to the Investment Company Institute. For a moderate investor, building a diversified portfolio can mean a large initial investment.
"A reasonable allocation might be 38 percent large-cap, 7 percent small-cap, 15 percent international, 30 percent bonds and 10 percent cash," Ibbotson said. "But if the minimum investment is $1,000 per mutual fund, you would need more than $14,000 to invest in those proportions."
But fear not, there may be a simple solution: a fund of funds. Commonly called lifecycle funds, lifestyle funds, target maturity funds or balanced funds, these investment products are whole diversified portfolios. Investors can select a fund of funds based on time horizon (when you're going to retire) or how much risk you can tolerate.
With one purchase, investors can get access to a diversified portfolio designed by professional money managers such as Old Mutual, Pioneer Investments and AIG SunAmerica, who have partnered with Ibbotson Associates to help create these fund offerings. Funds of funds can be thought of as one-stop shopping for your investment dollars. - NU
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