You’ve got money to invest but you’re not sure how much to put in stocks vs. bonds. Plus, how much to keep in cash? Or, maybe you’ve been investing for a long time but you’re not exactly young anymore. Should you be lowering the amount of stocks you own?
The best asset allocation at any age is going to strike a balance between being aggressive enough to get the upside of the stock market while also protecting some of your money through bonds or other fixed-income assets. The more risk tolerance you have, the more you should put in stocks. If you are leery of putting too much in stocks, you can dial back a bit on those and still have a portfolio that performs well.
Common Asset Allocation Formulas
The 100 Minus
In the past, a suggested formula for how much of your investing dollars to put into the stock market was this:
100 – your current age = % in stocks
In other words, if you were 25:
100 – 25 = 75% of your portfolio in stocks
If you were 55:
100 – 55 = 45% of your portfolio in stocks
The 110 Minus or 120 Minus
These days, few investment advisors would suggest the 100 Minus formula. With people living longer and their investments needing to last longer in retirement, it’s necessary to be a bit more aggressive in terms of exposure to the stock market. At the very least, most would suggest you change the formula to 110 Minus. If you are age 25, that of course means:
110 – 25 = 85% in stocks
If you are age 55, that means:
110 – 55 – 55% in stocks
Some would even suggest you go to 120 Minus, meaning our 25 year old would have 95% in stocks (120 – 25 = 95) and our 55 year old would have 65% in stocks (120 – 55 = 65).
My Thought: A Sliding Scale Based on Age, Performance, and Overall Wealth
Any formula you use will do better in some markets vs. others. If the stock market is booming, obviously people that took the higher risk and invested heavily in stocks will do better. But if the stock market is unsteady or even goes down, those will less exposure to stocks will do better.
That said, historically the stock market has far outperformed the bond market. The longer you have to invest before you need to take out money, the more it makes sense to be heavy into stocks. Even the biggest downturns in the stock market have reversed over time and given patient stock investors better returns than the bond market.
So, my thought is that you don’t strictly adhere to one formula. My advice would be:
Go heavy into stocks when you are young.
I would actually use a 125 Minus formula when you are young, as in (125 – your age = % in stocks). In other words, if you are 25 or under, you should have 100% of your portfolio in stocks. If you are older, use one of the other formulas based on your risk tolerance. (I tend to still go with 120 Minus even in my 40s. Not everyone is comfortable with that level of risk.)
Leave your portfolio alone and reassess every 5 years or so.
The 5s and 0s in our ages make good markers. If you’re 25, go 100% in stocks until you are 30, then reassess at that point. If the market has done really well, maybe switch to the 120 Minus formula to lock in some gains you’ve made. In other words, at age 30, you’d go from 100% stocks to a 90/10 ratio of stocks to bonds. If the stock market hasn’t performed well, you might stick with 100% stocks or at least stay with the 125 Minus formula and put just 5% into bonds. Remember, when you are only 30 you still have a long road ahead; it is entirely OK to be riskier and have most or all of your investment dollars in a diversified stock portfolio (such as an S&P index fund).
Now, using the earlier example of our 55 year old, at this age your assessment is more complex. You should be doing some calculations of how much money you’ll need in retirement and seeing how that jibes with your current portfolio. (There are plenty of retirement calculators on the Internet that can help you take a stab at how big your portfolio should be based on how much you hope to live on in retirement.)
If your portfolio is already very close to what you feel you’ll need in retirement, you probably want to change your asset allocation to be much more even between stocks and bonds, maybe using the 110 Minus formula or even 100 Minus if you’ve really done well. If you are still well short, you’ll probably want to stay more aggressive in your allocation (even if that makes you a little bit queasy).
Assess your allocation more often as you near retirement
The closer you are to retirement, the more you want to stay on top of your portfolio. You’re going to need some of that money soon, so it makes sense to monitor things more closely and make changes if need be.
Asset allocation in retirement
Once you’ve actually retired, you still want to be in the stock market. The formulas still apply. You may feel more comfortable going with the 100 Minus formula, but that still means you’d have 30% of your portfolio in stocks at age 70. That’s OK, because you have 70% of your portfolio in safer investments. But that 30% in stocks still gives you the opportunity for slightly higher gains. Remember, if you reach age 70, the current life expectancy tables say you’re likely to live another 14-17 years. You don’t want your money to run out before you do.
These Are Rules Of Thumb – Your Mileage May Vary
There is no “correct” asset allocation at any age. Any formula you use is based on educated guesses built off the history of the stock and bond markets. While it’s likely that the future will be somewhat like the past, there is no guarantee of that. That is why you need to reassess your situation throughout your life. Decide if you need to make changes based on the performance of your investments, but also based on your overall wealth. (The more money you have, the more you may be inclined to protect it versus trying to grow it, and vice versa.)
This is an article about asset allocation, but we’d be remiss if we didn’t mention the need to keep your portfolio diversified within each asset class. If you have 70% of your life savings in stocks, don’t have it be in the stocks of only 2 or 3 companies. Most people should be buying mutual funds or ETFs that have 100s of stocks or bonds within the fund, so a big downturn in one company can’t sink your whole portfolio. Index funds are usually the way to go, due to diversification and low fees. Vanguard is the best-known in terms of low-cost index funds, but there are others as well.
What about cash?
Most of your money should be invested, not sitting on the sidelines waiting for the “right time” to jump in. History has shown that it is virtually impossible to “time” the market. Those who jump in and out almost always have worse returns while also having to pay transaction fees on their trades.
The only excess cash you should have is that which you designate as an emergency fund. Calculate your monthly expenses and then keep 3-6 months worth in a cash-like account (savings or money market accounts, perhaps) that you can access easily if you lose a job, have health issues, etc. You obviously will also have some small amount that you keep in an everyday checking account to pay your bills and live your day-to-day life.
As mentioned, there is no “right” answer when it comes to asset allocation. Use one of the general rule-of-thumb formulas above and get started. Don’t wait and think “Oh, I really should do something with that money but I don’t understand my options.” In the end, you will have more stress by not investing and losing out on significant lifetime earnings than you would if you’d simply made a choice to get started.
Don’t stress. Just do it.
Blah-Blah Disclaimer: This is not specific investment advice intended for any specific individual. Investing involves risk and your decisions are your own, based on your personal financial situation. The author is not responsible for investment choices you make based on the guidelines in this article.