Diversifying your assets means not “putting all your eggs in one basket,” and asset allocation is the practice of achieving the balance between risk and reward.
There’s a handy little story on the SEC website that helps explain it:
Have you ever noticed that street vendors often sell seemingly unrelated products – such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never – and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses. And when it’s sunny, the reverse is true. By selling both items- in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.
Before I delve into the trade-offs of different allocations, it’s helpful to outline how this works in a Betterment account.
A diversified portfolio should be diversified at two levels: between asset categories and within asset categories. All Betterment customers invest in the same portfolio – a blend of stock and bond index exchange-traded funds (ETFs) that are efficient, liquid, and provide conservatively balanced exposure. They encompass thousands of companies in the US and overseas.
We’ve taken care of this decision, because frankly, it’s complex, time-consuming, and really, really hard to get right. Our investment advisory panel, made up of industry experts including economics professors and CFAs, took a critical eye to the stocks out there and selected the best mix of assets for someone looking for steady, long-term growth (which should be all of us!). See the details here.
In a nutshell – these assets make up our two baskets “Treasury Bonds” and “Stock Market”.
When you deposit money with Betterment, it is seamlessly invested in a blend of the two.
One Handy Dial
Betterment gives you control over the next level of diversification: the proportion of your money invested in each of these baskets. Setting the allocation between these two portfolios is the single investment choice Betterment customers make. It’s important because if you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. Too much risk and the money for your goal may not be there when you need it.
Help! How do I make such an important decision?
Don’t worry, tell us what your goal is, how much you need and when you think you will need it (as well as extra contributions you think you can make over time, such as regular auto-deposit). Betterment will make a recommendation for your asset allocation.
Your Portfolio vs. “The Market” – Comparing Apples to Fruit Salad
When you order fruit salad, you don’t expect it to taste like a single apple. If you’re invested in a diversified portfolio, it’s unrealistic to expect it to behave like Apple or even only U.S. stocks.
Diversification: Winning the War by Losing Battles
Diversification involves knowingly accepting some individual losses in order to gain long-term returns.
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