Strategy Beginner: Asset Allocation and the Investment Time Horizon

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Your child is about to enter college. Which portfolio is likely to be the most successful for your college-fund investments?

80 percent stocks, 20 percent bonds, 0 percent cash

60 percent stocks, 30 percent bonds, 10 percent cash

40 percent stocks, 40 percent bonds, 20 percent cash

20 percent stocks, 60 percent bonds, 20 percent cash

20 percent stocks, 60 percent bonds, 20 percent cash. With a short investment time horizon, youll probably want to have most of your funds invested in less-volatile instruments like bonds.

Short investment time horizons increase the risk of volatile investments.

True

False

True. Holding volatile investments for short periods increases the risk that your investment may not recover from a short-term price drop.

When planning for retirement needs, the best asset allocation strategy is to pick a portfolio of investments and stick with it until retirement.

True

False

False. Asset allocation should change as individuals approach retirement, the investment time horizon becomes shorter, and their reliance on income from investments increases.

Why might an asset allocation that is heavily weighted toward stocks, with only a small portion in bonds, be more appropriate for a 28-year old planning for retirement than for a 60-year old?

Younger people are less concerned about losing money than older people.

The 28-year old has a longer time horizon, and this will allow him or her to ride out temporary market fluctuations and take advantage of the long-term growth potential in the stock market.

This asset allocation would not be more appropriate for the younger person; the 60-year old should be equally heavily invested in stocks or stock mutual funds.

The general consensus among experts is that one should have zero exposure to the risks of the stock market once reaching the age of 60.

The 28-year old has a longer time horizon, and this will allow him or her to ride out temporary market fluctuations and take advantage of the long-term growth potential in the stock market. The older investor will have less time to make up for any short-term downturns in the stock market.

Which statement best describes the effect of investment time horizon on asset allocation strategies?

The longer you have to hold an investment, the more risk you can assume.

The longer you have to hold an investment, the more you should protect your capital.

The shorter your time horizon, the less risk you take with volatile investments.

None of the above

The longer you have to hold an investment, the more risk you can assume. This is true because long-term growth trends will tend to overcome short-term fluctuations in value. This is a key impact of investment time horizon on asset allocation.