Key #3

The greater the returns you seek, the more investment risk you must be willing to accept.

Generally, the more risk you take with your investments, the greater your potential gain—as is the greater your potential loss. Take for example the chart above. Over a 20-year period, large-cap stocks have clearly emerged as the best performing investment category. However, from the peak in 1999, large-cap stocks dropped a dramatic 37.5% through 2002. It's worth noting that even after such a dramatic decline, large company stocks still outperformed bonds during that 20-year period. In other words, a $100,000 investment would have gained $1,088,919 over twenty years, but would have lost $656,000 from its peak. Could you live with that kind of volatility? If not, you need to consider an allocation of investments that includes conservative investments.

Which investments offer greater potential returns and which ones offer less risk? The pyramid below illustrates how the basic investment categories relate to risk and return.

As you move down the asset allocation pyramid, the investment categories offer less risk in exchange for potentially fewer returns. On the converse, as you move up the investment pyramid, you accept more risk with potentially greater returns.

Of course in planning your asset allocation, you must remember the adage "Past performance is not a predictor of future results." While it is true that stocks generally perform best for periods of 20 years and longer, there is no guarantee that stocks will provide better investment performance than bonds over the next 20 years.

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