Devising an Allocation Plan

Once you assess your risk tolerance, it's fairly easy to draw up a suitable target portfolio. Essentially, this means earmarking a certain percentage of your investment dollars into stock funds, bond funds and "cash" ("cash" refers to fairly liquid but safe investments in places such as savings accounts, bank certificates of deposit and money market funds). This is known as asset allocation.

People using an asset allocation strategy essentially have a financial road map at their fingertips. They have a plan for staying in the stock and bond markets over the long haul, and they won't let short-term price declines send them scurrying to the sidelines. They learn to watch the performance of their portfolio as a whole, without worrying so much about fluctuations involving individual investments.

At its simplest, an asset allocation plan involves choosing among growth, current income or capital preservation.

All investments possess one or two of these traits but not all three. A money market mutual fund, for example, delivers capital preservation with current income but no real growth or appreciation potential. Common stocks promise growth--perhaps with some dividends on the side--but no assurance of capital preservation.

As a rule, stocks are most closely identified with growth, bonds with current income and money market instruments with capital preservation. An allocation plan would also include sub-categories such as small stocks, international stocks or high-yield bonds.