In this section: The SmartMoney Asset-Allocation System Why It Works

ASSET ALLOCATION is a crucial first step in creating a well-diversified portfolio. The worksheet below will help you tailor your asset mix to your own particular needs. If you are unfamiliar with what allocation means or how it works, click to the next page for a broader discussion and then come back here to complete the worksheet. Otherwise jump right in — click on any line of the worksheet for built-in instructions. One note: When we say assets here, we mean all of your medium to long-term investments, including money you're saving in a tuition fund as well as retirement savings. For advice on how to fold those disparate investments into your asset-allocation plan, see below. We should also point out that this is a guide, not a hard-and-fast plan. The mix you derive after running through the worksheet isn't meant to be set in stone. The more experience you get investing, the more you'll be able to fine-tune your investments to fit your needs and investment style.

Asset Allocation and Investment Goals Chances are, you've already got some money invested — retirement savings in your 401(k), a college fund for your kids, a little cash set aside for emergencies. We're not asking you to start all over. Instead, you should use those investments as the building blocks for your portfolio. In other words, you can simply fit the funds you've already chosen for your college fund or your retirement fund into the asset-allocation model. Say you already own a medium-volatility large-cap in your IRA. Go ahead and count that as part of your 50% allocation in large-company stocks. You can do the same with the funds you've selected for your college savings. Short-Term Investments Keep in mind, however, this allocation system is designed for your longer-term investments. Money already earmarked for short-term goals shouldn't be included — savings for a down payment on a new house you're about to buy, for instance, or your tuition fund if college is just a few years away. Because you have no time to make up a short-term downturn in the stock market, those kinds of savings demand a more conservative approach. For assistance with this, visit our Short-Term Investing department. Make It a Yearly Habit Asset allocation is easy — something anybody who is busy will appreciate. But since uneven price movements in your investments can upset the balance over time, it's best to rebalance each year. This has the added benefit of lending a vital measure of discipline to your investing. It prods you to take the appropriate amount of risk when you're feeling overly cautious. It reins you in during those times when the sky seems to be the limit. Say, for instance, you do the worksheet and your ideal allocation calls for 10% cash, 15% bonds and 75% stocks — with the stock portion split three ways between large-company, small-company and international equities. As the year progresses, your large-cap stocks fall 10%, but your small caps gain 15% and everything else stays about the same. At the end of the year, you'd have a choice of ways to restore the balance. You could use new money to buy more large-company stocks on the cheap, as well as a new portion of bonds and cash. Or you could sell some of the more expensive small-company winners and use the proceeds to invest elsewhere in the market. Buy low, sell high. It's fundamental to sound investing.