Posted by Maneesh Sethi :: October 16, 2007 @ 10:38 am

As you begin investing, you will probably be putting a lot of money in one type of investment---index funds, or stocks, bonds, CDs, and of course P2P loans. However, as your investments grow, you will need to consider how you will allocate your assets.

Asset allocation is the process of choosing where your investments will go based on your personal risk tolerance and your investment goals. Depending on your situation, you may want to take on more risk than other people. For example, if you are a student with very little debt and no spouse or children to worry about, your capability to tolerate risk is much higher than someone who is older and married with children. This means that you can afford to invest in riskier assets, such as certain stocks or higher-interest loans on Lending Club.

Why not just invest in one specific stock? Because of the benefits of diversification. Having a diversified portfolio will allow you to stomach fluctuations in the market, because even if one sector of the economy (and your portfolio) tanks, the rest of your investments will help keep you steady. For example, imagine if you only invested in tech stocks during the boom in 2000---after the stock market crash, your portfolio would have lost a huge percentage of its value. However, if you had balanced that investment with other sectors, as well as index funds and international stocks, your portfolio could have continued to do pretty well.

So how do you determine the best asset allocation? Well, there is no easy answer. A good way is to use some of the excellent asset allocation calculators on the web. My favorite is located here. The calculator takes into account several variables about you, such as your age and your tolerance for risk. Based on your information, it gives you a good idea of how to spread your investments. For example, for me--a young, very risk-tolerant individual-- the calculator recommends I invest most of my money in funds and stocks, and just a tiny portion in bonds and cash. This is the same plan that I essentially created for myself.

On Lending Club, you can control your asset allocation in one of two ways. When you let the LendingMatchâ„¢ algorithm build a portfolio for you, you specify your risk tolerance on a scale of 1-5, from conservative to aggressive. Your chosen risk level will then be used to create a diversified portfolio of many different loans. If you choose to build a portfolio from scratch instead, you will be able to set your own mix of loan grades and spread your funding across as many loans as you want - from only 1 all the way up to the total number of loans in inventory.

Having a good plan for how you will allocate your assets is very important for building a successful portfolio. Here are some other great resources that you can read to learn more about how to allocate your assets.

Money 101
Asset Allocation
Asset Analysis