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The ABCD's of Investing

If you have ever tried to read one of your 401(k) or IRA statements and got completely confused, you are not alone. If you have ever tried to pick mutual funds or stocks on your own, but had no idea where to start, you are not alone. If you have heard someone talk about “the benefits of diversifying your portfolio” and your head started spinning, you are not alone. The good news is, you are in the right place!


I am going to demystify some of the language you may be reading and hearing about and help you make sense of the jargon. I will describe the most common and important terms you need to know when investing and saving for your future goals. This is particularly timely since you may have noticed your retirement account making big swings lately. While this may be okay while you are young, the ups and downs of the market are not as fun the closer you get to needing the money.


Asset Allocation: Where you should put your money

Asset allocation is determining the amount of stocks, bonds, cash, and other alternatives (i.e., gold, real estate) that should be in your accounts. For example, an 80/20 asset allocation means you have roughly 80% stocks and 20% fixed income (bonds and/or cash). To determine what's best for you, you will need to know when the money is needed and your ability to tolerate risk. This is important because stocks and stock-based investments tend to fluctuate more compared to bonds and cash. If you have a longer time horizon, say 10 years or more, your portfolio has time to recover from any bumps in the road. Why would you want to take this chance? Because historically, stocks have tended to produce higher returns. If you need the money sooner or “can’t sleep at night” because you are worried about your investments, a smaller allocation to stocks may be appropriate no matter your timeframe. However, keep in mind that you are taking a risk no matter what because there are no guarantees when investing. Risk comes in several forms, such as inflation eroding your cash investments and rising interest rates causing bond prices to fall. You have to balance where you are comfortable with your time horizon.


(Re)Balance: Ensuring your money doesn’t get out of whack

Rebalancing is evaluating your asset allocation (see above) and buying or selling your individual investments to ensure they remain in the percentages you originally intended. For example, the 80/20 portfolio example above will not always stay 80/20 because investments go up, go down, and sometimes stay flat. When one portion of your portfolio does really well, the other investments that aren’t doing as well tend to lose their weighting. So, after a period of time, a well-intended 80/20 portfolio may become 85/15. To get the percentages back in line, you sell the better performing investments and buy more of the poorer performers. Sound familiar? Yep, you are buying low and selling high! Some 401k, 403b, and other employer retirement plans may even offer an automatic rebalance at set intervals, which makes the process much easier. Consider reviewing and rebalancing your accounts at least once per year and getting help when appropriate.


Correlation: How investments move relative to one another

Correlation is the relationship between two assets and can be positive or negative. A positive correlation means the investments move in tandem, so if one is doing well, so is the other, and vice versa. A negative correlation means the investments move opposite to one another. You will have investments that are both positively and negatively correlated. Finding negatively correlated investments is the more difficult task. Stocks (both domestic and international) and bonds, for example, were at one time considered negatively correlated, but over the past few decades, have moved in tandem. Gold is an example of an asset that has remained a negatively correlated asset relative to stocks and bonds. Real estate can also be an alternative. Cryptocurrency, once labeled “the new gold”, has actually behaved more like a tech stock. Understanding and allocating your portfolio with a focus on correlation can help reduce volatility.

Diversification: Not putting all of your “eggs” in one basket

Diversification is owning several different types of investments, such as gold, real estate, stocks, bonds, cash, crypto, even art or collectibles in order to limit your exposure to any one asset class. Diversification can sometimes be confused with asset allocation. Diversification breaks down asset allocation even further into subcategories such as domestic, international, government, large, medium, and small companies. Remember, it is important to do your research and understand the investments thoroughly before making any investment choices.


By implementing the ABCD’s of investing, you will not only be confident in your investment selections, but not let market swings, geopolitical tensions, inflation, and other factors (beyond our control) distract you from your goals. Creating a portfolio that accomplishes all of this does require some effort and research. These strategies are important to understand, but they are difficult concepts and if you are unsure, always seek help from a financial advisor, ideally a fiduciary or CERTIFIED FINANCIAL PLANNER™. Be cautious of advisors who earn a commission on the investments they sell to you. Even if unintentional, their sales model can have the appearance of a conflict of interest. An advisor who is fee-only or fee-based should share similar goals as you and provide unbiased investment advice.


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