How Your Age Can Help Determine Where to Invest
By Kara Stefan
It’s a common misconception that if you choose great stocks, your portfolio will perform well. That theory doesn’t always pan out for the masses. What does work is a strategy called asset allocation–which is simply spreading your money out across various asset classes, including stocks, bonds, and cash accounts.
You see, a widely recognized investment study revealed that approximately 91% of your portfolio’s return is determined by how your money is dispersed over these asset classes–not by what stocks you pick, and not by when you invest.
By Accident, or By Design?
Every investor uses some form of an asset allocation strategy, whether it’s intentional or not. You decide where to invest your money, and the result is the placement of some percentage of your portfolio into each asset class.
Some folks go all out, and invest their whole portfolio in stocks–whether in individual securities, stock mutual funds, or a combination of both. This would account for a 100% stock allocation and is considerably risky. On the other hand, some investors may stick with ultra conservative investments and place all their money in government and corporate bonds–for a 100% bond allocation. This approach also entails risk because the bonds may not earn enough to meet the investor’s financial requirements and goals.
The key to effective asset allocation is to strategically place a percentage of your assets into each asset class for the best performance results–and still be able to sleep at night.
Establishing your personal asset allocation strategy requires serious reflection and soul searching. You have to evaluate exactly what your monetary goals are, for now and in the future. You should have an idea of how long you can leave your money invested before you need to access it to pay for a home, college, or retirement income. And finally, you should know how well you personally weather volatile periods in the markets. If you’re inclined to sell as soon as prices begin to fall, you should shy away from higher risk investments.
Once you’ve determined your investment goals, timeline, and tolerance for market risk, you must translate that into an asset allocation strategy. This exercise is best conducted with an experienced and trusted financial advisor.
However, if you want to go it alone, some experts suggest the following basic calculation to give you a very general allocation split between stocks and bonds:
Subtract your age from 100. The resulting number is the percentage of the portfolio that should represent your stock allocation. For example, say you’re 35 years old. Since 35 from 100 is 65, stocks should represent about 65% of your investment portfolio, with bonds representing about 35%.
Keep in mind, however, that this is a generic trick of the trade and does not take into account any details about your specific situation. It’s just a place to start. If you’re uncomfortable placing 65% of your money in stocks, you can take a portion of that and put it into a cash account like a money market fund.
If you’re young and have ambitious financial goals, you may want to raise that stock allocation even higher. If you do so, however, remember to diversify your holdings to lessen your risk. In other words, don’t put 80% of your portfolio in one stock. Mix it up among mutual funds or securities that cover the spectrum of small, mid, and large cap stocks, and even international securities.
The more you diversify, the less volatile your investment will be. Some people argue that you also minimize your return potential as well. There is some truth to this, particularly if you diversify too much.
Ideally, you shouldn’t change your asset allocation based on market conditions, but rather only when your own financial goals or circumstances change. For example, as you grow older and approach retirement, you may wish to create a more conservative portfolio in order to protect your investment earnings. This scenario may call for a lower allocation of stocks and an increase in bond and cash holdings.
Whatever you invest in remember that assets are allocated either by design or by accident. But with over 90% of your performance results riding on this decision, you’ve got at least one good reason to count the candles on your birthday cake.