Investing Basics

Asset Allocation

We have already seen that Time and Volatility are two very important components in the investment mix.  The third key element is Asset Allocation.  The long-term success of your investment plan will be determined mainly by your asset allocation and your ability to stick to it.

Why is asset allocation so important?  Your asset allocation determines the volatility and return characteristics of your portfolio.  Over long investment horizons each asset class has a unique return-volatility profile.

Government Bonds

While government bonds provide low returns, their main advantages are the low volatility and safety of principle.

Stocks

Stocks have on average produced returns that are above inflation even if we spend the dividends that are distributed.  The main advantage of stocks is that they provide real long-term growth.  The main disadvantage is the higher volatility.

Real Estate

Real estate returns have historically been in a middle ground between stocks and bonds.  An investment in real estate offers real growth and may act as an inflation hedge.  Volatility lies in a middle ground between bonds and stocks.

Commodities

Commodities such as oil or gold have provided a hedge against inflation, but have offered ZERO long-term returns.  Their high volatility and low returns makes them unsuitable for investment.  They may serve a hedging purpose, or are otherwise purely speculative.

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