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When it comes to personal finance and investing there are many things that we need to keep in mind. Naturally there is personal budgeting and watching our outgoing expenses. Debt should also be taken into account and hopefully avoided whenever possible. Insurance, expenses for children, taxes and future planning are other areas of concern in personal finance.
Asset allocation is one area that unnecessarily confuses some individual investors. The idea is to diversify your investments in such a way as to take advantage of the diversity of different asset classes. Stocks, bonds, real estate, cash and commodities are just a few examples of asset classes available to us as individual investors. Research has shown that asset allocation may be the most important investment decision you can make, but how do you determine the best way to allocate your limited assets in a seemingly limitless field of investments?
One thing needs to be firmly kept in mind that the research into asset allocation was actually done using data from institutional investment accounts. Because most individual investors do not have nearly enough capital to properly diversify across all major asset classes, this research is not as relevant to the individual as one might expect. We can still take advantage of research by using investment vehicles such as mutual funds and exchange-traded funds (ETFs).
The advantage of these investments for the individual investor is that they diversify your assets while allowing for smaller investment amounts. For example, an investor with just $50k in assets would be hard pressed to develop a sufficiently diversified stock portfolio. This doesn’t even account for all the other possible asset classes that could provide protection when stock prices fall.
For example by using ETFs, an individual investor would be able to divide his wealth among different asset classes. There are often correlations between asset classes that make it possible to insulate yourself from the volatility inherent in the markets. When stocks are falling, bonds are often rising. When bonds are falling, commodities may rise. If commodities are falling, real estate may boom. By spreading your risk among different asset classes, you can limit your gains to some extent, but you are also reducing the volatility of your portfolio, allowing for a much smoother increase in your wealth.
While this article just touched on the importance of asset allocation for personal finance and investing, I think you get the gist. To learn more about the art of asset allocation you should visit the AmateurAssetLocator.com website where you can find more detailed information on different asset classes and how diversification can protect your portfolio.
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