Continuing our theme from last week, let's review three more of the finance terms folks report having little knowledge of: asset allocation, bull and bear market, and endowment. You may know these terms already and, if so, that's great. But since about 50-60% of Americans are either unaware of or aren't confident about the terms, let's dive in.
Asset Allocation – Asset allocation is a foundational component of financial planning and investment management, so it pays to know at least something about it. Weighty scholarly works have been written about the topic and it's hard to condense a definition down to a few paragraphs, but I'll try.
Asset allocation is a strategy that helps determine your investment return and the downside risk you'll have to endure to get it. Since more risk equals more return (and vice versa), the asset allocation process mixes riskier investments, such as stocks, with less risky investments like bonds and cash, to find the optimal blend for an investor.
Mixing different categories of investments together turns asset allocation into a series of tradeoffs. Do you want more growth over time? If yes, this means you'll need more stocks and will have to endure more downside risk in the short-term. Want more stability? If so, your allocation will require more bonds, cash, as well as lower expectations for growth.
Ideally, your asset allocation is based on your tolerance for risk and how hard you need your money to work for you. If created appropriately, your allocation should stay the same for a very long time and would only be altered if something fundamental changes in your life (not just because the market is down, political concerns, etc).