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Principle #2: Aim For the Right Average Rate of Return

The asset mix (the balance between stocks, bonds and cash) in your portfolio should be determined based on the rate of return you require in order to reach important goals.

In a well-designed investment portfolio, higher returns are associated with higher risks and wise investors assume no more risk than is necessary to achieve their financial goals. To ensure that you are not taking on more risk than necessary, you need an up-to-date financial plan that shows the rate of return you actually need to earn to reach your financial objectives. The target rate of return, and the asset mix used to earn it, should be detailed in your Investment Policy Statement.

The rate of return that you need should dictate the asset mix within your portfolio. The right asset mix is the one that can be expected to earn the necessary return with the least amount of risk. The allocation of your investments among the different asset classes such as cash, equity, bonds, global investments, etc, is the cornerstone of your investment policy or plan. In choosing an asset mix, the goal is to allocate assets to each asset class so that your required rate of return is achieved with the lowest amount of risk.

It can be tempting to assume more risk than necessary in an effort to generate higher returns. However, the danger of being in a portfolio with higher risk than necessary is not the normal fluctuation of the market, but rather the unexpected rare event that might cause a portfolio to fall so much it would take many years to recover.