We all know that investors benefit from diversification—that is, spreading your money across multiple types of investments. Because different investments tend to do well at different times, having a mix will help smooth out returns in the long run. But the specifics will depend on several factors, such as your goals, time horizon, and risk tolerance.
Moreover, the record number of available investment options can mean more opportunities for investors—but it can also make investment decisions more overwhelming than ever.
AMY ARNOTT, portfolio strategist for Morningstar Research Services, suggests that one answers these two questions before deciding the what (type of fund) and the which (name of the fund). This is a great starting point when cultivating a portfolio, and will go a long way in improving your investment outcome.
1) What is the appropriate time horizon, or holding period, for keeping this fund?
Match the time horizon for your specific goal with the appropriate investment. By matching a fund’s recommended minimum holding period with the expected time horizon for holding it, you can use your investments more effectively and reduce the risk of not having enough assets available to meet your various goals.
2) What percentage of my portfolio should I allocate to this fund?
Investors often spend more time thinking about whether a fund is worth buying than they do about how to use it—that is to say, how much space it should occupy within a portfolio. They then might end up with a large assortment of funds, with each one occupying a different percentage of assets depending on when it was purchased and how well it performed since that date. This can lead to disastrous consequences.
Riskier assets, such as stocks, are a better fit for long-term goals because they’re more likely to generate losses in the short term but have better growth potential over longer periods. Safer assets, such as short-term debt funds or fixed deposits, are a good fit for near-term funding needs, but not likely to generate high-enough returns to support funding for long-term goals.
