Managing Risk by Proper Asset Allocation

The concept behind asset allocation is to achieve a balance between the possible returns and the intrinsic risk of all investments. Since the returns on stocks, bonds, and cash seldom move together, having all three in a portfolio can reduce volatility over time by offsetting setbacks in one category through gains in another. Maximum invested capital should be no more than 50-75% of your total liquid assets. The remainder should be put in an interest-bearing savings account where there is little or no risk. This will assure that capital will always be available if a great opportunity presents itself.

Capital allotted to any one industry group should be limited to 25% of your investment equity. Your commitment to any one trade should be limited to 10 or 15 percent of your total investment equity. The total amount you are willing to lose should be limited to 10% of the amount traded.

Asset Allocation

Diversified, Diversified and Diversified

When investing, the old adage "never put all of your eggs in one basket" rings true. If you put all of your money into one or two stocks, industry groups, or sectors; and that part of the market goes into a decline, then your money declines right along with it. Make sure you divide your invested funds into a mix of different types of companies. Even in extremely bullish markets, not all stocks go up at the same time, and some will head downward while most stocks in their group are moving upward.

If you have too many stocks in one or two sectors, such as banking, raw materials, or energy; or if you have your money in only one or two stocks, and that sector or those few stocks go off the deep end, your portfolio will drown too. The best offense is always a good defense. By diversifying your portfolio, you can make sure you don't lose too much when the market or some of its sectors take a downward turn.