3. Don't let stock market conditions dictate your allocation strategy
When the economy is performing well, it's tempting to believe that the stock market will continue to rise forever, and that belief may encourage you to chase higher profits by holding more stocks. This is a mistake. Follow a planned asset allocation strategy precisely because you can't time the market and don't know when a correction is coming. If you let market conditions influence your allocation strategy, then you're not actually following a strategy.
4. Diversify your holdings within each asset class
Diversifying across stocks, bonds, and cash is important, but you should also diversify within these asset classes. Here are some rules of thumb to help you do that:
Stocks:
Investing in individual stocks isn't right for everybody. But if you choose to go this route, it's wise to hold 20 or more individual stocks to prevent relying too much on any single investment's performance. Alternatively, you can invest in mutual funds or exchange-traded funds (ETFs).
You can diversify your stock holdings by individual company and market sector. Utility companies, consumer staples, and healthcare companies tend to be more stable, while the technology and financial sectors are more reactive to economic cycles.
Mutual funds and ETFs are already diversified, and that's especially true when it comes to index funds that track broad indexes like the S&P 500.
Bonds:
Buying individual bonds can be a clunky and complex process. For most investors, the best way to go is investing in bond funds. The different types of bonds available are primarily municipal, corporate, and government bonds. There are excellent low-cost index funds for each type.
Cash:
Cash doesn't lose value like a stock or bond can, so diversifying your cash holdings doesn't necessarily need to be a priority. And to be clear, by "cash," we mean a savings account or CD, not physical cash.
If you have a large amount of cash, you may consider holding it in separate accounts at different banks, ensuring that all of it is FDIC-insured. The FDIC limit is typically $250,000 per depositor, per bank.
One smart strategy is to diversify how you hold your cash to maximize your liquidity and interest earnings. For example, you could hold some cash in a liquid savings account and the rest in a less-liquid certificate of deposit (CD) with a higher interest rate than a standard savings account.
