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Investors have a multitude of asset classes that they can use to create long-term wealth. For individuals who have recently entered the workforce, investing in equities or even high-risk alternate assets like Bitcoin may be a viable option. For younger investors, asset volatility is less of a concern as there is plenty of time for the portfolio to recover.
However, older investors cannot afford this luxury. Around 23% of 401 (k) savers are heavily invested in equities and baby boomers are most likely to commit this investment mistake. You can however reduce exposure to stocks in two ways- by manually rebalancing your account each year or by letting a fund do the rebalancing for you.
Rebalancing your portfolio involves selling your position and using these proceeds to buy other investments. The primary goal is to achieve a robust composition of stocks, fixed income and liquid cash that’s appropriate for your age
Your portfolio should contain a mix of asset classes with a shifting emphasis of certain investments over others depending on your age.
As a rule of thumb, you can subtract your age from 110 and the resulting number is the percentage of stocks that’s safe to hold at this age. Alternatively, you can also invest in a target-date fund which automatically rebalances your portfolio.
How does these passive funds work?
The composition of these funds gradually gets more conservative as you near the target date which is the year you expect to retire. The target date fund is designed to be the only position in your retirement account.
So, in case you allocate 50% of your savings in a target-date fund and the rest in an S&P 500 ETF, you will have a high exposure to equities. You need to focus on creating a diverse portfolio as it opens the door to wealth-building opportunities over time and it can also protect you against periods of stock market volatility.
Even if equities account for less than 50% of your portfolio, it is advisable to further diversify your holdings and buy stocks across sectors. Bonds too work similarly. You can buy bonds issued by companies from different market segments or you can also invest in a mix of corporate and municipal bonds.
Index funds are passively managed funds that aim to match the performance of the market indexes they are associated with. Index funds such as the S&P 500 allow you to enjoy broad market exposure that can be attained without too much leg work.
The S&P 500 has generated annual returns of 10% in the last 55 years, making it one of the top picks for your investment portfolio.
The bottom line
Investing is not easy as there is a large pool of options and asset classes that can be considered. However, if you are a disciplined investor with a long-term view, diversifying your investments will help you create substantial wealth over time.
Related: Why the S&P 500 Index Should Be a Core Part of a Portfolio!
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