You have money to invest, but don’t know how much to place in stocks or bonds. What about cash balance? You might be an older investor who has been investing for a while but isn’t quite young anymore. Do you need to reduce the number of stocks that you have?What’s the best asset allocation for my age?
Asset allocation is best at any age. It should strike a balance between being aggressive enough in order to reap the benefits of the stock markets while protecting your money with bonds or other fixed income assets. Stocks should be a part of your risk tolerance. You can reduce the amount of stocks you own and still have a portfolio that is performing well.
Common Asset Allocation Formulas
The 100 Minus
The following formula was used in the past to determine how much of your investment dollars you should put into the stock exchange:
100 – Your current age = % of stocks
Also, imagine if you were 25 years old:
100 – 25 = 75% your portfolio in stocks
If you were 55:
100-55 = 45% of your stock portfolio
You have money to invest, but aren’t sure how much. Do you need to reduce the number of stocks that you own?
A good asset allocation is one that balances risk and reward. You can reduce your stock holdings but still get the best returns.
Common Asset Allocation Formulas
The 100 Minius
In the past this was the suggested formula to determine how much of your investment dollars you should put into the stock exchange:
100 – your current age = % in stocks
Or, in other words:
100 – 25 = 75% your portfolio in stocks
If you were 55:
100 – 55 = 45% your portfolio in stocks
Don’t worry about your portfolio. Reassess it every five years.
Markers are the 5s and 0s of our ages. When you reach 25, you should invest 100% in stocks. Once you reach 30, you can reassess your position. To lock in any gains, you might switch to the 120 Minus formula if the market is doing well. This means that at 30 you would have a 90/10 ratio between stocks and bonds. You might choose to keep your 100% stock portfolio, or stick with the 125 Minus formula with 5% in bonds, if the stock market isn’t performing well. You still have a long road ahead of you, even though you’re only 30. It is perfectly acceptable to take greater risks and invest most or all your money in a diversified stock portfolio such as the S&P index fund.
Now let’s take the 55-year-old example and make a more complicated assessment. Calculating how much money you will need to retire should be your first step. Then compare that with your portfolio. There are many retirement calculators online that will help you determine how large your portfolio should look based on what you expect to have in retirement.
If your portfolio is close to the amount you think you will need for retirement, you might want to adjust your asset allocation. You could use the 110 Minus formula, or 100 Minus, if you have done really well. You might want to be more aggressive with your allocation if you are still short.
As you approach retirement You should assess your allocation more frequently
You should be more vigilant about your portfolio the closer you get to retirement. It’s likely that you will need the money in the near future, so it makes sense for you to keep an eye on your portfolio and make adjustments if necessary.
Retirement Asset allocation
You can still be a part of the stock market even after you have retired. These formulas are still applicable. While you may be more comfortable with the 100 Minus formula than others, it still means that 30% of your portfolio would be in stocks by age 70. This is okay, as 70% of your portfolio will be in safer investments. You still have the chance to make slightly more with 30% of your portfolio in stocks. Keep in mind that if you are 70 years old, current life expectancy tables suggest you will live for another 14-17 year. Don’t let your money run out before it is needed.
These are Rules of Thumb – Your Mileage May Vary
There is no one “correct” asset allocation for any age. Your formula is based upon educated guesses based on the history of the bond and stock markets. It’s possible that the future will look somewhat similar to the past but there is no way to know for sure. This is why it’s important to periodically reassess your entire life. You should not only evaluate the performance of your investments but also your overall wealth. You may feel more inclined to keep it safe than to try to grow it.
Keep Diversified
Although this article is about asset allocation, we would be remiss if it didn’t mention how important it is to diversify your portfolio within each asset class. You shouldn’t invest 70% of your savings in stocks. Don’t limit yourself to stocks owned by just 2 or 3. Many people should buy mutual funds or ETFs with 100s of stocks and bonds. This will ensure that your entire portfolio is protected from a downturn in any one company. Because of their diversification and low fees, index funds are often the best option. Vanguard is the most well-known for low-cost index funds. However, there are many others.
How about cash?
Your money should be invested and not sitting around waiting for the “right moment” to invest. It is almost impossible to “time the market,” as history has proven. Jumping in and out of the market almost always results in lower returns, as well as having to pay transaction fees. Although trading fees are no longer as high as they were in the past, they are much lower now and often non-existent.
You should only have enough cash to cover your emergency funds. You should calculate your monthly expenses. Then, keep at least 3-6 months of that amount in a cash-like account, such as savings or money market accounts. This account can be accessed easily in case you lose your job, get sick, etc. You will need to keep a small amount in your everyday checking account to pay your bills, and for your daily life.
Don’t Stress
Asset allocation is a complex topic. Start by using one of the following general rule-of thumb formulas. Do not wait to start thinking “Oh, I should really do something with this money, but I don’t know what my options are.” You will end up feeling more stressed if you don’t invest and you will lose significant lifetime earnings compared to if you made the decision to get started.
Don’t stress. Do it.
Blah-Blah Disclaimer : This article is not intended to be specific investment advice. Investing is risky and you must make your own decisions based on your financial situation. The author cannot be held responsible for any investment decisions you make based upon the information.