Why do I need asset allocation?

Get more reach with less risk

If you’ve ever tuned in to one of those money-focused TV programs with fast-talking hosts, you might think that investing is all about picking hot stocks and frantically following trends. But the average person chasing the latest success story can often end up with disappointing returns. Wouldn’t you rather invest strategically and tune out the news about the rising or falling market? It can be done with the help of asset allocation.


Weigh risk and returns

Risk and return go hand in hand. You can’t have one without the other. Generally, the more risk you take on, the higher the potential returns.


The challenge is to find the right balance between investments risky enough to provide some growth and those conservative enough to maintain a good night’s sleep. How you choose to spread your money among different investment types is called asset allocation.


While diversification is about investing your dollars in more than one place, asset allocation involves larger categories of investment types, known as asset classes.


Stocks are an asset class; so are bonds. In different markets, stocks and bonds may act differently. Investing in both can help lower the risk of everything getting hit at the same time and to the same degree. This can help reduce the effects of volatility.


Keep an objective in mind

Mutual funds can help take a lot of the guesswork out of asset allocation. A fund can represent an asset class or even an allocated portfolio. They also come with their own objectives. Are you focused on growth at any cost? There’s a fund for that. More concerned with keeping what you already have? There’s a fund for that too.


As an example, here are some categories typically found in retirement investing plans, sorted by relative risk: 


  • Growth funds primarily invest in stocks of growing companies with the potential for above-average gains. The prices of these stocks may have higher highs and lower lows from day to day.


  • Growth-and-income funds typically invest in stocks of more established companies that have good earnings prospects and pay dividends, which is a form of profit-sharing that can provide additional income. This income helps cushion those extreme market ups and downs.


  • Equity-income funds invest primarily in dividend stocks as well as bonds. These funds tend to produce lower returns compared to growth funds when the stock market is on the rise. But the income that comes from investing in solid companies can soften the impact when the market falls.


  • Balanced funds typically invest in a combination of stocks, bonds and cash to balance the goals of growth, preservation and income.


  • Bond funds invest primarily in bonds or short-term, cash-like investments and are designed to provide regular income from the interest that bonds pay. Bond funds can help investors ride out stock market downturns but tend to have lower returns.


Find your fit

Your work as an investor is to strike a balance that makes sense for you. To do this, start with the number of years you plan to be invested. Generally, the more time you have, the more risk you can afford to take. When you are young, with plenty of time on your side, you may choose to put a larger share of your money in investments with a high potential for growth, like stocks. As you near retirement, you might move money into conservative investments, like bonds. These investments may grow more slowly, but the money is more likely to be there when it’s needed. You can work with a financial professional to create an allocation matched to your unique needs and goals.


Set a rebalancing schedule

Once your asset allocation is set, all that’s left is keeping it that way. As investments grow or fall in value, allocations can shift over time. If one portion of your portfolio is outperforming, it will grow more quickly than the others and upset your overall mix.


The easy solution is to check in yearly to rebalance your investments. Rebalancing generally involves selling investments that have performed well and buying more of what has not done well, with an aim to bring your allocation back to match your individual needs and goals. If it seems counterintuitive to take money from an asset that’s up and move it to one that’s down, think of it as realizing profits in one area to buy possible bargains in another.


Consider investments that can do the work for you

If you want an even easier way to get allocated, there are mutual funds that can do the work for you. These “funds of funds” invest in a variety of mutual funds to achieve a certain asset allocation. One popular type is the target date fund, which you choose based on the year you plan to reach your goal. It’s managed so the asset allocation changes over time — going for growth initially and becoming more conservative as the target date nears. You could also use target date funds to invest for a goal with a set date, from paying for college to retiring.

Related articles

Stocks and bonds: What’s the difference?

Master the basics of mutual funds

Benefits of long-term investing

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Although target date portfolios are managed for investors on a projected retirement date time frame, the allocation strategy does not guarantee that investors' retirement goals will be met.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only.
Effective July 1, 2024, American Funds Distributors, Inc. was renamed Capital Client Group, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.