Once an investor understands the basic asset classes, how does that investor choose a portfolio? What mix of assets is appropriate to an investor? I believe that this is one place where many investors go wrong. But choosing a portfolio should not be that difficult.
Some investors choose very “safe” assets like money-market funds for their 401(k) or other investment accounts. Or they invest solely in bonds. This “safe” portfolio may have relatively little volatility during their accumulation years. But, 30 or 40 years later when the investor retires, the safe portfolio makes their retirement risky because they have not accumulated enough for retirement. In the long run, bonds don’t normally earn enough to fund a retirement portfolio.1 Neither do other “safe” investments like money market funds or bank CDs.
At the opposite extreme, there are those investors who are sure that they can do better than their peers by concentrating on one risky asset. They focus on real estate alone (and invest in only one location in the United States). Or they load up on their own company’s stock. Or they swing from one “hot” investment to another. Today it’s MLPs, master limited partnerships that invest in energy infrastructure. Two or three years ago, it was gold. Seven years ago, it was any type of real estate including condos in Las Vegas. A few years earlier, it was tech stocks.
Diversification pays. It may be boring, but it offers ...