You have been saving in your 401(k) for years. But now you’re ready to start an investment account as well. Whether you’re going to buy some stocks on your own or work with an advisor who will build and manage a portfolio for you, here are some investment terms that you should know (and how they impact your money).
- Asset Allocation. Asset allocation is one of those investment terms many people think they know, but don’t really understand. Still, it’s actually a pretty simple idea.
- What it means. Asset allocation is about building a balanced portfolio that can help you withstand whatever happens in the market. It’s the investment strategy that helps you divide your money among different categories of investments, such as stocks, bonds and cash, based on your goals, how much risk you’re willing to take and how long until you’ll need your money (your time horizon).
- Why it matters. Stocks, bonds and cash tend to respond differently to market conditions (one may go up when the others go down). Asset allocation helps you spread your money so that when one asset class unexpectedly zigs, your whole portfolio doesn’t zig along with it. In this way, asset allocation can help ensure your portfolio is correctly positioned to help you reach your financial goals, no matter what is happening in the market.
- Diversification. The terms asset allocation and diversification are often used interchangeably, but they’re not the same. If asset allocation is the recipe for creating a sound portfolio, diversification represents the ingredients.
- What it means. Diversification is the process of taking the money you have allocated to each asset class and spreading it among a variety of investment types that don’t typically move in lockstep. That way, if one investment takes a tumble, others may move higher, helping to smooth the returns over your overall portfolio.
- Why it matters. Together, a sound asset allocation strategy and a well-diversified portfolio can help lessen the impact of market ups and downs on your portfolio.
“Portfolio rebalancing may prevent you from buying or selling investments based on emotion.”
- Dollar cost averaging (DCA). Dollar cost averaging is a term for putting your investment plan on autopilot.
- What it means. With DCA, you invest a set amount at set intervals (for example, $200 every month) in the market. By investing systematically, you’ll buy more shares of an investment when the market is lower, fewer when the market is higher, and some when the market is in between. Over time, this may help you to pay a lower average price for the total shares you purchase.
- Why it matters. DCA can take the emotion out of investing, helping you to start on your investment plan sooner, rather than later. And once you begin, DCA can also help you remain focused on your goals, no matter what’s happening in the market. It helps make investing a habit.
- Portfolio Rebalancing. Of course, nothing stays the same when it comes to investing. The asset allocation strategy you set will drift over time. That’s because some investments will grow and become a bigger part of your holdings, while others shrink. That could leave you with an allocation of 70 percent stocks and 30 percent bonds when you started with (and really want) 60/40. This is where rebalancing can make a difference.
- What it means. Portfolio rebalancing simply means restoring your portfolio mix to your original plan by selling some investments and buying others. It’s about keeping your eye on the big picture — your financial goals and the strategy you’ve put in place to help you achieve them — and periodically adjusting your investment mix to bring it back to your target allocation.
- Why it matters. Rebalancing on a regular basis (once or twice a year, for example) can help ensure your portfolio remains aligned with your goals. And because it provides a disciplined approach to investing, portfolio rebalancing also may prevent you from buying or selling investments based on emotion.