After the extreme volatility in various financial markets over the past two and a half years, many investors are looking for mutual funds that don't require them to put all their eggs in one basket, such as stocks. Asset allocation funds, which invest in more than one financial market at a time, can provide you that diversity.
"These are very appropriate for the average investor because it gives you diversity and risk management, which are difficult things for most people to do on their own," says Michael Dixon, director of wealth management for Carl Domino Inc., financial advisers in Palm Beach, Fla.
The most basic form of an asset allocation fund is a balanced fund. These funds go back about 70 years and are balanced between stocks and bonds.
Traditionally, the allocation was about 60 percent stocks, 40 percent bonds and was fixed. Now the funds come in an array of different allocation percentages, and some funds even shift their percentages from time to time according to market conditions.
Fund evolutionOver time, the funds have diversified. "Rather than just having large cap stocks and high-grade bonds, they've gone to a broader mix of equities, bonds and cash," says Greg Carlson, a mutual fund analyst at Morningstar research firm in Chicago.
"Now there will be a broader mix of equity bonds and cash. Often it will be a fund of funds, including large cap stocks, small cap stocks, foreign stocks, high-grade bonds and junk bonds."
And in the latest evolution of asset allocation funds, they have turned to alternative asset classes, such as commodities, real estate and currencies.
"There are a number of new funds over the last 12 to 24 months that provide a combination of asset classes that previously weren't available as a package," says Michael Sheldon, chief market strategist for RDM Financial Group in Westport, Conn.
"If you believe interest rates and inflation will rise, for example, there are funds that invest in a combination of TIPS (Treasury Inflation-Protected Securities), real estate, commodities, floating rate debt and other securities."
One of Sheldon's favorite funds invests in domestic and foreign stocks, domestic and foreign bonds and, to a small extent, in gold. "The goal is global diversification with moderate risk," Sheldon says.
Here are five important questions to ask yourself when considering an investment in asset allocation funds.