Asset Allocation

• What Is Asset Allocation?
• Focus on the Three Primary Asset Classes: Stocks, Bonds, and Money Markets
• Diversification: The Basis of Asset Allocation
• Asset Allocation Can Work
• Asset Allocation: Learn the Strategy for Boosting Potential Returns
• Points to Remember

In today is complex financial markets, you can select from an impressive array of investment vehicles. Each investment also carries some risks, making it important to choose wisely if you are selecting just one. The good news is that there is no rule that says you must stick with only a single type of investment. In fact, you can potentially lower your investment risk and help increase your chances of meeting your investment goals by practicing “asset allocation.”

Asset allocation refers to the way in which you weight investments in your portfolio in order to try to meet a specific objective. For instance, if your goal is to pursue growth (and you are willing to take on market risk in order to do so), you may decide to place 20% of your assets in bonds and 80% in stocks.

The asset classes you choose, and how you weight your investment in each, will probably hinge on your investment time frame and how that matches with the risks and rewards of each asset class.

Stocks: Well known for fluctuating frequently in value, stocks carry a high level of market risk (the risk that your investments value will decrease after you purchase them) over the short term. However, stocks have historically earned higher returns than other asset classes by a wide margin, although past performance is no predictor of future results. Stocks have also outpaced inflation — the rising prices of goods and services — at the highest rate through the years, and therefore carry very low inflation risk.

Bonds: In general, these securities have less severe short-term price fluctuations than stocks, and therefore offer lower market risk. On the other hand, their overall inflation risk tends to be higher than that of stocks, as their long-term return potential is also lower.

Money market instruments: Among the most stable of all asset classes in terms of returns, money market instruments carry relatively low market risk. At the same time, these securities lack the potential to outpace inflation by as wide a margin through the years as stocks.

*An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

Different investments offer different levels of potential return and market risk. Unlike stocks and corporate bonds, government T-bills are guaranteed as to principal and interest, although money market funds that invest in them are not.Past performance is not indicative of future results. **Sources: Standard &Poors; Center for Research and Security Prices; Morgan Stanley; the Federal Reserve (Jan. 1, 1985, through Dec. 31, 2005). Large caps are represented by the annual total returns of the S&P 500. Mid caps are represented by the annual total returns of the composite of CRSP 4th-5th decile portfolios and the S&P MidCap 400 Index. Small caps are represented by the annual total returns of the composite of CRSP 6th-8th decile portfolios and the S&P SmallCap 600 Index. Foreign stocks are represented by the annual total returns of the MSCI EAFE Index. Bonds are represented by the annual total returns of long-term Treasuries (10+ years maturity). Cash is represented by the annual total returns of 3-month T-bills. Investors cannot directly purchase an index

Before exploring just how you can put an asset allocation strategy to work to help you meet your investment goals, you should first understand how diversification — the process of helping reduce risk by investing in several different types of individual funds or securities — works hand in hand with asset allocation.

When you diversify your investments among more than one security, you help reduce what is known as “single-security risk,” or the risk that your investment will fluctuate widely in value with the price of one holding. Diversifying among several asset classes may increase the chance that, if and when the return of one investment is falling, the potential return of another in your portfolio may be rising (though there are no guarantees and the total value of your portfolio may decline).