First off, it’s important to get a better understanding of the nature of stocks, bonds and mutual funds.
Stocks – stocks are long-term investments with the the potential for very high returns but carry great risk.
Bonds – bonds are also long term investments. When compared to stocks, they are significantly less risky and offer a much lower rate of return.
Mutual funds – mutual funds are medium-term investments. They are more risky and offer higher returns when compared to bonds but yield lower and are less risky when compared to stocks.
In deciding on the optimum investment portfolio for these securities, the following are important:
Age of Investor
As an example, a younger person with a greater appetite for risk, simply because there is more time to recover from mistakes, could opt to invest more in stocks and mutual funds. However, an older person, as a general rule, is more concerned with security and as such should opt to invest more in bonds, less in mutual funds and even less in stocks.
The Financial Objective of the Portfolio
This has to do with whether the investor is concerned with security or returns or a mixture of both. If the investor is in a speculative mode and or mainly concerned with maximizing returns, stocks and mutual funds are the best bet but if the focus is on security, bonds are the recommended option.
If the investor has funds available for only a limited time, it may be wise to stay away from mutual funds where it can take very long to recover from upfront load fees. Bonds too may carry encashment penalties. Although stocks are long-term investments, giving all due consideration to risk appetite, exploiting the day trading phenomenon may be the best alternative.
The investor’s goal may be to save for retirement. In such an instance, security is more a priority better satisfied by an investment portfolio skewed towards bonds.
Some investors are by nature averse to risk. In such instances, bonds which provide a steady income stream are the best.
Cash Resources Available
The larger the resources available, the more liberal one can be in skewing a portfolio towards mutual funds and stocks.
With all that said, it’s always advisable to consult with a Financial Planner who can work through the many scenarios using “allocation models” and offer proper investment advice.