Using asset allocation to build an investment portfolio

When it comes to building up your investment portfolio, there are three asset classes to invest in. They are cash, bonds and stocks. The goal of the investor is to have an asset mix that reflects their risk return profile. Depending on the investor’s situation, one asset class will likely be dominant in their portfolio. Of the three, cash is considered the most secure. It also offers the lowest returns. These are money held in bank and brokerage accounts or short term deposits. Cash positions are usually built up to take advantage of lower priced stocks and bonds.

Bonds are debt issued by governments and corporations. The duration of these debts are longer than one year, pays interest every 6 months and the principal is repaid at maturity. The coupon rate on the bond denotes the interest paid to the holder at par. The yield of the bond is dependent on the issuer’s credit rating and term. The lower the credit quality, the bond yield will be higher to compensate for the higher risk. The longer the duration, the bond yield will likely be higher. There is less certainty that the issuer will repay debts over the long term versus the short term.

Stocks represent ownership in publicly traded corporations. Prices of stocks are linked to the fortunes of the companies. If the companies do well, growing their sales and profits, their stock price will go higher. If the company continuously loses money, the stock price will likely go lower. Over the long term, stocks generate the greatest returns of the three asset classes. It is also the most risky.