Determine the Percentage to be Allocated in Each Major Asset Class
The first step in creating a diversified mix of investments is to choose the percentage that should be invested in each Major Asset Class (stocks, bonds, cash equivalents/stable value). Stocks are growth investments, and should represent the portion of your portfolio that will continue to grow for some time. Bonds are for stability and income. Cash equivalents and stable value investments are designed to provide predictable interest returns and liquidity.
The pie charts shown here are designed to help provide a starting point for allocating your assets. Remember, asset allocation is different for everyone, so, these are guidelines not rules. However, one strategy remains constant throughout these sample asset allocations - when the time horizon is increased, you should increase the percentage to stocks and decrease the percentage to income producing investments. Likewise, as you near retirement age you should increase the allocation to income producing investments, because you'll begin spending some of your money in the near future. When choosing your mix of investments you will have to make some assumptions about time horizon and life expectancy. Generally, you should plan to retire in your 60's and live into or beyond your 80's. It's better to have an over-funded retirement account than an under-funded one.
After you have determined the appropriate mix of Major Asset Classes, you will need to choose Mutual Fund Asset Classes to fill those allocations. Again, you should keep in mind diversification (spreading your investments into several different categories). The idea is to reduce risk by avoiding extremely high allocations to any one fund. This is limited primarily to the stocks category, because there are so many different types of stock funds (large-cap, foreign, etc.). Generally, you can use just one fund in the bond category and one from the cash equivalents/stable value category, because you'll be using a high-quality bond fund, and cash equivalent/stable value funds contain very similar investments, unlike stock funds which vary significantly.
For example, everyone should have stocks as one of their Major Asset Classes. But that doesn't mean you should pick just one stock fund for your entire stock allocation. Instead, you will want to spread your stock allocation over at least two different types of stock funds. However, you will probably want to have a larger allocation to the more aggressive categories (small-cap, mid-cap, etc.) when you have a longer time horizon. Then, as your time horizon decreases, you should lower your exposure to aggressive stock funds and increase the allocation to more
conservative stock funds, like large-cap stock funds.