What are the four most common investment objectives?

All investors want to make money, but often they have differing financial goals. Whatever your investment objectives, it's imperative that you formulate a plan and stick to it in good times and bad. The four most common objectives are: financial security, retirement planning, income to meet living expenses and a child's education. You may be seeking one, a combination or perhaps entirely different ones. Whatever your objectives are, they should establish a destination, as well as a chart for measuring your progress. At times, securities markets will turn, and you will be tempted to change direction abruptly. Your objectives should serve as a road map for managing your investment program. [Top]

What is dollar-cost averaging?

Dollar-cost averaging involves regularly investing a fixed sum -- say, $100, $300 or $500 a month. Your 401(k) salary deferral contributions automatically transfer into the fund every month. To understand how dollar cost averaging works, consider this example from the Dun & Bradstreet Guide to Your Investments. "You put $100 into a mutual fund every month. The shares fluctuate in price between $5 and $10. The first month you buy 10 shares at $10 each for a total of $100. The second month, because the market dropped, the shares are selling at $5 each, so you buy 20 shares at $5 and so on. At the end of four months you have acquired 60 shares for your $400 at an average cost of $6.67 per share" -- even though the average price of a share for the period was $7.50. In short, dollar-cost averaging commits you to a regular investment program (which is good) and guarantees that over the long haul, you'll buy more shares at lower prices than at higher prices (which is even better). It's an especially easy strategy if most of your money is invested in mutual funds. [Top]

What is asset allocation?

Asset allocation is the process of deciding how much of your investment portfolio should go into stocks, bonds or other asset classes (as opposed to picking individual stocks or bonds). Your decision in this respect is perhaps the single biggest factor that will determine your long-term investment outcome, so make it carefully. The basis of your decision is how much risk you are willing to take and your investor life cycle phase. More risk should mean, over the long term, a higher return.

A key factor that determines how well your investment portfolio performs is the way in which you allocate your assets. For example, if every penny you own is invested in high-risk, you have the potential to earn huge profits-or lose everything that you have invested. Conversely, if you have your money allocated among several different kinds investments-stocks, bonds, money market funds and the like-your return is likely to be lower but your chances of losing everything are slim. Younger people can generally afford to take more risks than older people, in part because younger people simply have more working years ahead of them to earn money and bounce back from an investment that turns sour. Older people have to be more conservative, because their highest-earning days are behind them and recouping from a bad investment would be more difficult. An asset allocation strategy can help you to accomplish two important goals: first, it can help you to ride out the ups and downs of the market by diversifying your investments, and second, it lets you adjust your exposure to risk, based on your desired levels of safety and return on investment. [Top]

What is an asset allocation, or lifestyle, fund?

An asset allocation fund, sometimes called a lifestyle fund, is designed to provide you with the diversification needed to weather virtually any market or economic environment. Most of these funds have been created over the past five or six years. They typically invest in a variety of assets -- domestic stocks, foreign stocks, bonds, money market instruments -- that you'd normally buy in separate funds. Many 401(k) plans now offer several asset allocation funds, each with a different investment mix and risks ranging from the very conservative to the very risky. In essence, when you invest in a lifestyle fund, you're hiring a manager to make your asset allocation decisions for you. [Top]

What does it mean to rebalance a portfolio?

You may strategically allocate your portfolio to certain percentages of asset classes. For example, you may allocate 40% of your portfolio to bonds and 60% to stocks. That allocation makes you comfortable and is designed to achieve your investment goals within your risk tolerance and investment horizon. Stocks experienced exceptional growth over the last three years compared to bonds. As a result, you may discover that the value of your portfolio is now 25% attributable to bonds and 75% to stocks. The greater growth in the return on stocks than the return from bonds resulted in this imbalance from the original 40/60 mix. Now, you are underexposed to bonds and overexposed to stocks. A stock market correction would have a greater effect on your portfolio, one you would be less comfortable with than under the original allocation. Therefore, it is time to rebalance your portfolio to reflect your strategic allocation of 40% bonds and 60% stocks. To do this you would sell stock and use the proceeds to buy bonds until the original mix is restored and you are back on track with your investment plan. A rule of thumb is to rebalance your portfolio when the weights deviate from the original by 10 percent or more. [Top]