2. Plan Your Mix
Once you’ve decided on your goals and determined your target dollar amounts, it’s time to pick your overall mix of investment types. Deciding how much investment risk you can take on should be based on where you are in life and the amount of time that you have.
Determine your asset allocation.
One way to help guard against risk is to allocate your money across asset classes, such as stocks, bonds, and cash—a strategy known as asset allocation.
To further offset risk, you should consider diversifying investments within each asset class too. That means spreading your money across different sectors, industries, and companies.
Identify your risk tolerance.
Use the asset allocation models below to help you determine your ideal mix of investments based on the amount of risk and reward you are comfortable with.
Use our asset allocation models to determine your risk tolerance
Here are some asset allocation examples based on historical data (1970–2012); examples assume a hypothetical $10,000 initial investment and annual compounding. Use the buttons below to explore the different scenarios and see the best- and worst-year returns.
Source: Charles Schwab Investment Advisory, Inc. (CSIA), an affiliate of Charles Schwab & Co., Inc. ("Schwab") with data provided by Morningstar, Inc. The return figures for 1970 through 2012 are the compound average, the minimum and the maximum annual total returns of the hypothetical plans, include reinvestment of dividends, and are rebalanced annually. The indices representing each asset class in the historical asset allocation plans are S&P 500 Index (large-company equity); Russell 2000 Index (small-company equity); MSCI EAFE Net of Taxes (international equity); Barclays US Aggregate Bond Index (fixed income);' and Citigroup 3-month US Treasury Bills (cash equivalents. CSRP 6-8 was used for small-company equity prior to 1979, Ibbotson Intermediate-Term Government Bond Index was used for fixed income prior to 1976, and Ibbotson 30-Day US Treasury Bills were used for cash equivalents prior to 1978). Indices are unmanaged, do not incur fees or expenses and cannot be invested in directly.
And just as you allocate your investments across the above classes, you will also want to consider dividing, or diversifying, your investments within each asset class. This involves spreading your money in different sectors, industries, regions, and companies in the hope that if one investment loses money, the other investments will offset those losses. Historically, different types of investments have reacted differently to market cycles and interest rate changes, so combining them can help reduce overall portfolio risk. If one asset dips in value, another may remain stable or rise, potentially buffering the high and low swings in the value of your overall portfolio.
Market Risk: The risk that you will lose money due to the ups and downs of the market.
How You Might Counter: Hold a mix of investments—i.e., diversify—to help lower your risk potential by spreading money across and within different asset classes, such as stocks, bonds, and cash.
Interest Rate Risk: The risk that interest rate changes will impact the value of your investments.
How You Might Counter: Interest rate risk primarily affects bond prices, which tend to move in the opposite direction from interest rates. For example, the prices for long-maturity bonds tend to fall more than short-term bonds when interest rates rise. One way to reduce interest rate risk is to stick with bonds with short to medium durations. Their prices are less sensitive to rising interest rates, and their shorter-term nature allows investors to invest in higher yielding bonds as rates increase.
Inflation Risk: The risk that your investment income and gains won't keep pace with price increases for goods and services.
How You Might Counter: Look at investments that can help to protect you against rising inflation, such as Treasury Inflation-Protected Securities (TIPS). Stocks and real estate have also been used in the past for some level of protection against inflation.