Strategy Beginner: Asset Allocation and the Investment Time Horizon

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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 of the following investment portfolios is the best example of diversification through asset allocation?

Industrial, utility, and transportation stocks

US Treasury bonds and municipal bonds

Stocks, bonds, and cash (e.g., certificates of deposit)

Certificates of deposit, passbook savings accounts, and money market accounts

Stocks, bonds, and cash (e.g., certificates of deposit). Unlike the other choices, these all represent different asset classes -- asset allocation consists of building a portfolio of different asset classes.

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.

Long investment time horizons decrease the risk of volatile investments.

True

False

True. Holding volatile investments for long periods increases the likelihood that long-term growth trends will overcome short-term price fluctuations.

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.