The Best Allocation of Stocks & Bonds by Age

As one grows older, a lot of changes can take place in one’s life – your preferences, hobbies, food habits to your health, profession, and personal life. As you age, your lifestyle may change too. Your needs and wants would also alter. Most people in their 20s are more at ease to take risks. They have fewer financial responsibilities. Concerns like buying a house or sending a child to college come in much later. As you move to your 30s, things may change a bit. If you are considering marriage, you may have to take on additional financial responsibility along with your spouse. If both partners are working, the thought of buying a house or starting a family and saving up adequately for the same is often a major financial concern for couples. The journey of life continues and your financial responsibilities keep changing and evolving up until retirement.

Investing your money gives you the financial freedom to fulfill all your goals, regardless of the age or stage of life you are in. It helps your money grow and offers you the chance to be prepared for any curveball that life throws at you, no matter how big or small. But in order to truly gain benefits from your investments, you need to pick the right investment instruments. These can be chosen based on a number of factors, such as your age, income, risk appetite, investment purpose, tax concerns, and more. All of these factors can alter and fluctuate over time. However, it is important to modify your investment portfolio along with your changing needs to ensure that your returns are optimal and able to cater to your needs. If you need help with choosing your investments or designing an optimal investment portfolio that best suits your financial needs and goals, consider hiring a professional financial advisor who can assist you.

The financial strategy to select asset allocation by age is a common method that most investors use as a benchmark to ensure that their portfolio returns stand the test of time and deliver results that can benefit them at every stage of life. The right bonds, stocks, and assets to invest in can differ for different people. However, some common tips can be applied to most portfolios. Keep reading to find out more.

What is asset allocation?

Asset allocation is an investment strategy that decides the percentage of each asset class on your financial portfolio. It aims to balance risk and reward as per the chosen investment horizon. Asset classes are primarily divided into three categories:

• Equities
• Fixed-income assets
• Cash and equivalents

For instance, here’s an investment portfolio example:

If an investment portfolio comprises 60% stocks, 30% fixed income assets, and 10% cash, its asset allocation would be 60 – 30 – 10. This 60% of stocks can further be divided into small, mid, and large cap stocks, foreign stocks, etc. 30% fixed income assets can be divided into corporate, municipal, and government bonds, high yield bonds, etc. And lastly, cash can consist of money market accounts, bank accounts, and more. 

Asset allocation can primarily depend on the following factors:

• Financial goals: Your future goals determine the kind of asset classes you should be investing in.
• Risk appetite: Stocks can be volatile but also deliver higher returns compared to other asset classes. However, fixed-income instruments can provide you with more stability. So, depending on the level of risk you are comfortable with, you can decide the percentage allocation for each of these funds.
• Investment horizon: Risk can be distributed over the long term, so if you have a long-term goal, you may opt for high-risk options like stocks that may be highly volatile in the short term. 

What is a stock portfolio?

An investment portfolio is an assortment of different financial products like stocks, bonds, cash, cash equivalents, commodities, real estate, exchange traded funds (ETFs), etc. A stock portfolio is a collection of only stocks. Your stock portfolio would contain all the stocks you have invested in. A good stock portfolio would be well diversified that can deliver good returns over time. A stock portfolio can be created on the basis of your age, financial goals, and investment budget. It also reflects your risk appetite.

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How much should I invest in stocks and bonds as per my age?

There is no fixed percentage of stocks for every age. And sometimes, a 60 year old can have more financial liabilities and goals than a 40 year old. So, the ultimate distribution has to be done based on your unique situation and what goals you want to fulfill. However, generally speaking, there have to be some alterations made to your investment portfolio as each decade comes and passes by. The 100 rule is the most commonly used rule for this purpose.

As per the 100 rule, you can simply subtract your present age from the figure 100. The remainder should be the percentage of stocks in your investment portfolio. So, if you are 30 years old, you should aim to have 100 – 30 = 70% of stocks. The remaining 30% can be divided into bonds and cash. If you are 60 years old, you should aim to have 100 – 60 = 40% of stocks. The remaining 60%, in this case, can be divided into bonds and cash. As you can see, the 100 rule gradually lowers the percentage of stocks as you grow old. The philosophy behind this rule is to lower risk and volatility from your portfolio with age.

The important thing to consider here is that the 100 rule is not conclusive and may not suit every investor. With increasing life expectancy figures, it is becoming increasingly common for people to continue working up to their 70s. The longer you work, and the more you delay your retirement, the more risk you can afford to take. The main reason why financial advisors often advise moving to fixed income assets pre and post-retirement is because your ability to take risks is reduced in retirement. You have a limited pool of money in your reserve and cannot risk it to earn more. Therefore, people are normally advised to aim for capital preservation and not appreciation. However, if you continue to work till the age of 70, and are earning perhaps the highest salary of your professional life in your 60s as a result of years of hard work, you do not necessarily have to cut stocks and move to bonds. As long as you have your income to rely on, you can still choose to allocate a relatively higher percentage to high risk stock options.

How to decide the right asset allocation as per your age

Here‘s how you can decide the asset allocation at different ages:

o   In your 20s and 30s

This is a phase where you start planning for long term goals like retirement or college education funds for your kids. The investment horizon is longer, and your risk appetite is higher. However, you may not have as many funds to invest at this age, as you would be just beginning your career. You could also have student loans to repay. Therefore, exposing yourself to too much risk can lead to stress and anxiety.

A workplace account like a 401(k) retirement account can be your savior in these years. If you have a 401(k) retirement account, try to maximize your contributions and concentrate on aggressive growth over bonds. If you do not have one, you can open an Individual Retirement Account or IRA. Along with this, you can consider investing in mutual funds, direct equity, exchange traded funds, and some corporate bonds, and also maintain an emergency fund in a bank account as a cash reserve.

o   In your 40s and 50s

This may be a time when you are at a higher pay scale. You may even earn the highest salary of your career during this phase. However, your financial liabilities and expenses will also increase. Loans, mortgage, taxes, school or college fees, utility bills, lifestyle choices, etc., can amount to a lot. Nevertheless, you still have many years left to retire, which keeps your risk profile high and offers you time to make a profit and overcome potential losses. A lot of people want a direct answer to – “how much should I have in my 401k at 30” or “how much should I have in my 401k at 40”. Some people think that you should have at least three to four times your annual salary saved up by this age. But as stated above, there is no fixed rule for everyone.

Regardless of where you stand at this time, you must aim to keep a high proportion of stocks in your portfolio. If you are lagging behind your retirement, this is the time to catch up, and a heavy concentration in stocks can help you do that. However, the percentage of stocks in your investment portfolio at this age will also depend on when you plan to retire. If you have 20 odd years ahead of you, you have little to worry about. However, if you wish to retire in the next 5 to 10 years, you may want to shift your 401(k) retirement account and IRA assets to bonds. This will provide you with more stability.

o   In your 60s

This is the closest you can be to retirement. This stage in your life can be full of personal and professional changes. Hence, it may be advised to stick to stable fixed income assets like bonds along with cash. Over the age of 60, it may also be advised to keep your 401(k) retirement account concentrated in bonds and cash.

o   In retirement

Contrary to popular perception, retirement is not a time when you should be averse to the idea of investing in stocks. Considering the fact that your retirement can last for many years, a mix of stocks, fixed income assets and cash can offer you the necessary level of growth. However, it may be recommended to lean towards a modest allocation in stocks, and show more fidelity to the other two classes.

What you should keep in mind when selecting an asset class

Selecting the percentage of an asset class is not the only thing you should be concerned about. It is also important to diversify your holdings across these asset classes.

Here are some things you can keep in mind:

• Stocks: Pick across mutual funds, exchange-traded funds, index funds, etc. Also, choose stocks from different industries, sectors, companies, and market capitalizations. Optimal diversification can help you earn more.
• Bonds: Diversify your bond by investing in municipal, corporate, and government bonds.
• Cash: Diversification here can mean holding cash in different forms, savings bank account, money market accounts, certificates of deposit, etc.

It is also important to rebalance your portfolio every now and then. Rebalancing refers to bringing the percentage of asset allocation back to what it was when you started. Portfolio rebalancing can help you stay steady in your investment journey.

To conclude

Asset allocation by age is a great investment strategy to ensure that you stay on track with your goals and dreams. It can help you plan optimally for a secure retirement and reduce financial anxiety along the way. In addition to this, it also helps to take remedial action in the case of errors or if you find yourself falling short of your goals and preferred timeline.  If you are not able to pick the right asset allocation as per your age, consult a professional financial advisor who can help you devise the best strategy for you.

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