Risk aversion is a prime reason to consider asset allocations.

Risk and reward are the balancing scales of investment. It is the hope that the greater the risk the greater the reward; hence the lower the risk, the lower the reward. Asset allocation, using diverse investments, is a method of evening out those scales to increase the overall reward while decreasing the overall risk.

Basic Structures

There are two basic structures to consider with asset allocations:

-       Time Line

-   Risk aversion

Time Line

Time line is described as a period in which you want to reach your financial goal. The longer the time line, the higher the comfort level with riskier stocks, as this will allow for the ups and downs of market fluctuation. The shorter the time line, the lower the comfort level with riskier investments, as the cash is needed in a shorter time and needs to be safer, to be available when needed.

The difference in the goals and investments could be compared to investing for retirement versus investing for a child’s college education. With retirement, the goal is several decades away and has a better chance of reaping the rewards from a higher risk investment as the market fluctuations will generally yield an overall higher return. Whereas investing for a child’s education may only be five to ten years away, and the risk of losing the investment is more adverse.

Risk Aversion

Risk aversion, or sometimes called risk tolerance, is described as how willing you are to risk losing most or all of your entire investment for a potential high return. An aggressive investor is one with a high-risk tolerance who is more willing to risk losing their investment to get better results compared to a conservative investor who has a lower risk tolerance and wants to protect their original investments.

Both the high-risk tolerance and the low-risk tolerance strategies have their pros and cons; therefore, it is a personal decision as to how much you are willing to risk.

Assets to Be Allocated

There are generally four types of investments which fall into asset allocations:

-      Stocks

-       Bonds

-    Cash

-     Tangible assets

These assets comprise one’s investment portfolio. Each one affects the other as the investment market fluctuates, so when one investment is giving a high return, one of the others is giving a lower return.

Asset allocation concerns when you take the investment in one (which is giving the lower return or the risk is higher) and invest it in another (which is giving a higher return or the risk is lower) at such a time when the overall risk is lower and the overall return is higher.

Again, remember the balancing scale between risk and reward; allocations come when the scales are not balanced and you are trying to make adjustments to get the highest return on your investments with the lowest risk.

Stocks

Historically, of the four investment options, stocks have been the riskiest of investments as they have the highest level of return with the greatest risk of loss. They are used for the long-term financial goals as they tend to level out over time and still provide a higher-than-average return on investment.

Because of the drama involved in their highs and lows, this is not generally recommended for the low-risk tolerance investor, the short-term investor, or the faint of heart. If the investor’s portfolio is not experiencing the growth they are seeking, and they are willing to take on more risk, investing in stocks can be a good way to increase their growth.

Bonds

Bonds are considered safer, with less fluctuation, than stocks. Although high-yield, or junk bonds, carry the same high-risk, high-reward returns of stocks, many other types of bonds are lower risk with modest returns. It is sometimes preferred to take the earnings of the stocks and transfer them into bonds in order to capture those high-risk rewards and maintain the comfort and modesty of growth with bonds.

The closer one is to reaching their financial goals, the better the bond option looks as it has a higher level of safety than stocks and many investors will trade the higher risk for the comfort of stability.

Cash

Cash comes in a variety of forms. Some forms include savings accounts, certificates of deposit, treasury bills, money market accounts and money market funds. They are the safest investments and as such have the lowest returns. Many of these investments are backed by a government guarantee and still have a very low risk of being lost.

The highest risk in these types of investments is the risk that inflation will overcome their growth to the point where there is no actual return.

Tangible Assets

In addition to the common investments of stocks, bonds and cash, some investors also include tangible assets. These assets can include real estate, private equity, commodities and precious metals. Although their risks and rewards are not valued as other assets, they are investment tools that are dependant upon your time line and risk aversion levels.

Many times, real estate investments are used for long-term retirement goals, such as the house the investor plans to live in when they retire; or short-term financial goals, such as the house they are planning to sell to finance their child’s education.

Whatever investments, or allocations you are considering, make sure the risk and reward levels are comfortable for you before making them.

Additional Resources

For more information, visit these Web sites:

• U.S. Securities and Exchange Commission at http://www.sec.gov/investor/pubs/assetallocation.htm
• Money Under Thirty at http://www.moneyunder30.com/asset-allocation-for-investors-under-thirty
• Bfinance.com at http://www.bfinance.co.uk/content/view/11957/1000283/