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Asset allocation in hard times

Then you can select investment vehicles that match the plan you've drafted.

For most individual investors, that will probably be mutual funds (like index funds) that have a wide variety of investments in that asset class. For instance, if you want large cap stocks, that portion of your money might go into an index fund that mirrors the S&P 500. Using funds gives you even more diversity, because you're not counting on the performance of one single asset, but an entire group of assets in that class.

"For better or worse, most of us live in an economy where it makes sense to segregate money for different goals"

Want to check your portfolio's diversity? Investor information sites like Morningstar.com allow you to enter your picks and will spit out a graph that shows where your investment falls in terms of the various asset classes, says Berg.

"It gives you a quick and dirty" way to see just how diversified you really are, he says.

What about the family with many goals? A bigger home in five years; sending the kids to college in a decade and retiring 25 years from now? Don't mingle that savings or the plans, say some experts.

"For better or worse, most of us live in an economy where it makes sense to segregate money for different goals," says Berg.

One solution: Get an education IRA or 529 plan for the kids, keep funding your retirement and look at a shorter-term savings vehicle for that house money.

Definitions
  • Index fund -- fund made up of stocks represented in a particular index.
See the Guide's Glossary for a further explanation of these terms.

And, with the economy rocky, don't underestimate the importance of another asset: cash.

Especially now, investors "need to have a cash cushion as part of their plan," says Cabaniss, who recommends keeping six months of living expenses in a liquid form like a high-interest savings account, money market account or short-term CDs.

"In down times, it isn't so easy to get a job and if you don't have any reserves, you could be hurt."

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Change of plans

During bumpy economic times, your asset allocation plan can serve as a touchstone to keep you on track. That can prevent you from giving in to panic and making some very costly mistakes. But one plan won't last a lifetime. You'll actually need several to reach your goal. The secret, say financial planners, is to use your life, not the ups and downs of the economy, as the signal to revisit your formula.

Important life events like changing retirement plans, divorce, remarriage, a significant windfall or change in cash flow, or the death of a spouse also signal times that you want to take another look at your allocation plan. Even if your life stays exactly the same, you want to revisit your plan every three years or so.

"Just ask yourself, does this still reflect me and my goals?" says Altfest.

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