So I put all my accounts through to Fidelity. Now what? It’s time to do the asset allocation dance…
When people talk about asset allocation, they usually just mean stocks and bonds. Stocks are ownership in a company. When you own a share of a company, you are own part of that company. If there are 100 shares in a company, and you buy one share, you own 1% of the company. When the company does well, the stock price goes up; when the company does…not so well, the stock price goes down. Investing in stocks can be very risky, because the company can go bankrupt, and all the money invested in the company (in stocks) will be lost. Generally, this doesn’t happen, but the risk is that you could lose your entire investment. However, a company could do extremely well, and the stock could shoot up in value (just as it could come crashing back down: see dot.com bubble).
Bonds are essentially an IOU. Governments (federal, state, local) and businesses issue bonds, you buy the bond, the bond pays interest during the life of the bond, and you get your initial money back at the end. The life of the bond could be anywhere from one month to thirty years. Bonds are generally safer than stocks, and as the risk is less, so is the growth potential. That is, the interest paid on bonds is usually less than the return on stocks. Less risk, less reward.
So the conventional thinking is that when people are younger (assuming that this money is for retirement), they can withstand the greater risk in stocks, and should hold more of their assets in stocks. As you get older, the tolerance for risk goes down, because the investment time frame is shorter, and you don’t have as long to allow a stock to recover if price if it falls. At this point, you want to preserve the money that you have, and you shift more money to bonds.
Of course, this is a vast simplification of stocks, bonds, and asset allocation, and leaves out many of the nuances and other asset classes, but we are just starting…
