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Asset allocation reduces volatility

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All-terrain vehicles
Lifecycle or target funds are one-stop shopping vehicles that do the asset allocation work for you. Fund managers adjust their composition to a more conservative stance as the target date to retirement draws near. "It's the difference between having a manual transmission, where you have to do the work yourself, or an automatic," says T. Rowe Price's Ritter.

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You can identify the one for you by matching your retirement date with that of the fund, such as Retirement Fund 2015.

If you're a do-it-yourself type of investor, you can diversify by allocating your assets among the various types of investments within each category. For example, the money you plan to invest in stocks shouldn't go into a particular type, such as high-tech, small-cap or even large-cap, but rather a mix of these and others. Diversifying in this way further reduces risk and maximizes returns.

Be careful, though, that you don't buy two funds with essentially the same stocks. To avoid overlap, check the sectors represented in the funds to make sure your investments are truly diversified.

Rebalancing your portfolio
Once you've determined your asset allocation, you'll want to maintain that allocation for a while. Periodically adjust your portfolio so the percentages remain constant.

Typically, your 401(k) will get thrown out of balance over time as some investments grow faster than others. For example, say you started out with 60 percent in stocks. The past year has been a roaring bull market. Now your stocks make up 80 percent of your portfolio while bonds are down to 20 percent. You should rebalance by selling stocks and buying bonds so your portfolio is back in synch. That's a successful investing technique called buying low and selling high.

It's easier said then done because it's counterintuitive. You're selling off what's done well and buying up what's been underperforming.

"It just doesn't feel right," says Matthew Tuttle, a certified financial planner and president of Tuttle Wealth Management in Stamford, Conn. Simply because it doesn't feel right doesn't mean it's wrong.

Rebalancing your retirement savings once a year should be sufficient. Time it to the New Year, your birthday or Bastille Day -- whatever day works best for you.

Asset allocation is the single most important determinant of portfolio returns, say financial analysts. Paying attention to this investment approach will go a long way toward ensuring a comfortable retirement.

Bankrate.com's corrections policy -- Updated: Oct. 1, 2007
 
 
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