Allocate Your Assets Like a Pro

Equity: This asset class includes individual stocks and stock funds. This is the most volatile (or "risky") of the three classes, so portfolios with higher proportions of equities are more prone to fluctuations in value than they would be if they were made up mainly of the other two classes. With this risk, however, comes the greatest historical return on investment. (If you need help handling the ups and downs of this asset class, check out the "Stock Doc" Column.)

Fixed-income: For our purposes here, fixed-income investments are more commonly known as bonds. While not as volatile as equities, bonds don't historically offer the same gains as the stock market does. (To learn more about bonds, check out "Getting Started With Bonds".)

Cash (and equivalents): This is the least volatile of the asset classes. This class is (quite literally) money in the bank. Money markets , certificates of deposit (CDs ) and the like are the short-term investment funds that comprise cash.

While there are some special types of assets that can span a couple of classes at the same time (for example, cumulative preferred stock), most beginning investors' assets will typically fall into one of the three main classes. (Other asset types to be covered in the future include derivatives, precious metals and real estate.)

Manage Risk, Reach Your Goal

With asset allocation, your goal is to decrease the risk in your portfolio as you approach your goal. For example, as an eventual retiree, you want to slowly decrease your retirement account's volatility as you approach the day that you you'd like to actually retire -- locking in the gains that you've already made on riskier investments.