The Proper Asset Allocation of Stocks and Bonds by Age
Understanding the right mix of stocks and bonds for your portfolio as you age is crucial to maintaining financial security throughout your retirement. Here’s why getting it right matters: If you invest too heavily in stocks close to retirement and the market takes a dive, you could face financial setbacks. On the other hand, over-investing in bonds throughout your career might prevent you from accumulating enough wealth to retire comfortably.
While there’s no one-size-fits-all solution since everyone’s financial situation and goals are unique, I can offer some general guidance on finding an optimal asset allocation as you age. This strategy aims to give you a more than 70% chance of meeting your financial goals based on my experience and research.
Asset Allocation and Risk Tolerance
Your mix of stocks and bonds largely depends on your personal risk tolerance, which can change over time. For example, if you’re young and able to handle more risk, you might lean more heavily into stocks. However, if you’re older or more risk-averse, especially like many of us feeling the strain of recent economic uncertainties, you might find a conservative approach more suitable.
Your investment strategy should also consider how crucial your portfolio is to your retirement plans. Those who don’t have other significant assets may rely more heavily on the performance of their retirement accounts, like 401(k)s or IRAs. However, if you have other resources like real estate or business investments, you might view your stock and bond investments differently.
For instance, I have about half of my net worth in real estate because it offers stability, physical asset security, and rental income, which tempers the volatility I’d rather avoid in the stock market. Only about 30% of my net worth is in equities because of this preference.
Analyzing My Asset Allocation
Using tools like Empower or Personal Capital’s Investment Checkup can provide insights into whether you’re taking on too much risk or not investing enough in bonds according to conventional wisdom for someone your age. It’s a straightforward process that can greatly inform your investment strategy.
Different Asset Allocation Models
Here are five asset allocation models tailored to different risk profiles:
1. Conventional Model: Suggests subtracting your age from 100 to determine your stock allocation percentage. This traditional approach assumes a decrease in risk tolerance as you age.
2. New Life Model: This model adjusts the conventional advice, suggesting subtracting your age from 120, reflecting longer life expectancies and the need for longer-term growth.
3. Survival Model: Ideal for the risk-averse, this model advocates a balanced 50/50 approach between stocks and bonds, providing a buffer against market downturns while still capturing growth.
4. Nothing-to-Lose Model: Suited for those with a high risk tolerance or a longer timeframe, this model typically involves a heavy or total allocation to stocks.
5. Financial Samurai Model: A blend of the above, tailored to modern economic realities with adjusted expectations for lower future returns.
Each model serves different investor needs based on their life stage, risk tolerance, and financial goals. The key is to choose one that allows you to sleep comfortably at night and meets your financial objectives.
Other Considerations
Beyond stocks and bonds, consider diversifying into real estate or private equity for additional income and growth potential. Real estate, for instance, can offer the income stability of bonds with the growth potential of stocks, especially in favorable markets.
In conclusion, setting the right asset allocation involves understanding your personal risk tolerance, life stage, and financial goals. Regular reviews and adjustments will ensure your investment strategy remains aligned with your long-term objectives, helping secure your financial freedom in retirement.
