8/1/2010 9:00 AM ET|
Determine your asset mix
PORTFOLIO 105: Your asset allocation is your portfolio's blend of stocks, bonds and cash. Finding the best asset mix is crucial if you want to meet your goals.
You've built your emergency fund, determined your goals and their costs, and thought about how much risk you can take. But how do you know which securities to buy? Which ones are going to get you where you need to go?
Before you begin choosing individual mutual funds and stocks, you need to think in broader strokes. You need to consider your asset allocation.
Your asset allocation is your portfolio's blend of stocks, bonds and cash. Finding the best asset mix is crucial to meeting your goals. In fact, most financial advisers agree that setting up the right asset mix is more important than choosing great investments. Determining your asset allocation is easier than ever, thanks to a variety of online calculators and other tools.
This course addresses what you need to know before determining your asset mix and how to use Morningstar.com's Asset Allocator to figure out your blend. It will also discuss the limitations of online asset-allocation tools.
What you need to get started
No matter which asset-allocation tool you use, you'll need to know a few bits of information first. For starters, you need to know your goal. Let's say it's to have $1 million when you retire. You then need four pieces of information about that goal to determine your asset mix.
- The number of years until your goal is reached. You want to retire in 30 years. That's the number of years to your goal.
- How much money you need for your goal. You want to have $1 million when all is said and done.
- How much money you can invest right now. You have $20,000 set aside, so that's your starting amount.
- How much money you can contribute each month. You can invest $800 per month.
Using Morningstar.com's Asset Allocator
Morningstar.com's Asset Allocator can show you how likely you are to reach your goal using a variety of asset blends. It tells you how much risk you'll need to assume to get close to your goal. (Note: Asset Allocator is a benefit of Premium Membership. If you're not a Premium Member yet, you can sample the benefits for free with a trial membership.)
Figuring out what your portfolio should look like is just a matter of plugging in the appropriate information.
For example, we've filled in Asset Allocator's blanks using the information from the last step in this course. The Portfolio Value is $20,000, Monthly Investments are $800, Number of Years is 30 and Financial Goal is $1 million as a lump sum.
Asset Allocator's default asset mix is 0% cash, 30% bonds, 45% large-cap stocks, 15% mid-/small-cap stocks and 10% foreign stocks. The probability of reaching the goal given this default mix isn't that great, though. Asset Allocator estimates that you have only a 26% chance of winding up with $1 million. Your possible three-month loss from this portfolio is an estimated 10.3%.
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