Asset allocation makes a huge difference when planning for retirement. A well-diversified portfolio can help you minimize risk and take advantage of the ups and downs of the stock market.

Learning the secrets of portfolio management can feel like cracking the secret code on a safe. How do you determine the right mix of stocks, bonds, real estate, and cash to assure a healthy retirement? Brushing up on the basics of asset allocation can help you open the door to untold fortunes.

Asset allocation 101

The following tips will help to demystify the world of diversification:

1. Determine your risk tolerance. How much money can you afford to lose in the market? Your answer will determine your risk tolerance. If you have many working years before retirement, your portfolio can afford to be more heavily weighted with stocks. On the other hand, if retirement is around the corner, it's wise to have more fixed-income investments, such as bonds or CDs.

2. Diversification is key. Diversifying among different asset classes, including stocks, bonds, real estate, and cash, will protect you from market fluctuations and reduce risk. It's intelligent to have a balance of companies with different market capitalizations, including international stocks and a variety of industry sectors. Also, you'll want to avoid being invested too heavily in one single company or asset class.

3. Ignore historical results. You'll often see the saying, "Past performance is no indication of future returns." Believe it. With proper asset allocation, the strongest performers in your portfolio are the ones that you'll need to sell. This way, you can move money into underperforming sectors, which are likely headed for recovery mode.

4. Review your portfolio regularly. Set a reminder to evaluate your investments, preferably on a yearly basis. This way you can transfer money to maintain the appropriate asset allocation.

CDs for fixed-income investors

Typically, investors look at bonds for the fixed-income portion of their portfolios. However, certificates of deposit (CDs) are an excellent alternative. Here are a few advantages of CDs:

1. Maximum flexibility. Financial institutions offer creative products, like liquid CDs, that allow you to access your funds without penalty, and bump-up CDs, that allow you to increase your rate if CD rates suddenly rise.

2. Competitive interest rates. Financial institutions are constantly competing for your investment. As a result, CD rates are competitive.

3. Ability to spread investments over various terms. You can invest in a CD for as little as one month, or as long as 120. This automatically allows you to take advantage of rising rates.

Understanding the benefits of using CDs as an investment for the fixed-income portion of your portfolio can definitely pay off. You can earn competitive interest rates, and protect your portfolio from market risk.

Use an asset allocation strategy to minimize your portfolio's fluctations. Not only will you break the code for a successful retirement, you'll continually increase the money in your retirement safe. The key to this success is to know the right combination of assets.

Published on December 30, 2008