The perfect investment strategy is something that is hotly debated amongst investment professionals and laymen alike, and it’s no wonder why. Economic performance is notoriously hard to pin down and is frequently proven to be very hard to predict.
There are many that claim to know the best way to allocate your assets, but they’re far from a consensus. It’s simply the case that the best strategies are constantly changing and that the unique financial situation of each individual plays a crucial factor in determining the best investment strategy.
In the midst of all the different ideas and preferred methods, there is at least one generally trusted rule of thumb that’s been around for decades, and it involves determining asset allocation by age.
Every investment portfolio is made up of assets. Assets are anything you own that is of value and includes things like real estate, cash, savings accounts, and investments. In the last post (will link blog), we spoke of the importance of intelligent asset management.
How you allocate the assets in your portfolio determines how aggressive or conservative your portfolio is. The more aggressive your portfolio, the more risk you take on in favor of higher potential gains. This type of approach is usually best for investors with longer time horizons. Long-term investments are typically able to outlast any short-term losses incurred due to market volatility.
A more conservative asset allocation means that the risk associated with your investments is lower. Of course, this also means that the potential for sky-high returns is lower. This is a worthwhile tradeoff for those wishing to safeguard their assets or those with shorter investment time horizons.
The three main asset classes are broadly referred to as stocks, bonds, and cash and cash equivalents.
Stocks are considered the most aggressive investment type because they are associated with a higher level of risk. This also means that they have a higher return potential.
Bonds are typically less risky investments than stocks, but they forgo such a high potential for returns.
Cash and cash equivalents (things like collectibles and precious metals) are least risky types of assets. The biggest concern with cash, for example, is inflation risk. While these assets are very secure, they offer much less in terms of returns.
Asset Allocation Based on Age
In addition to risk tolerance, the two biggest deciding factors in determining your ideal asset allocation are your time horizons and your financial goals. Your time horizons determine how long you’re able to hold on to your assets before you liquidate them. This has a direct effect on the level of risk your portfolio can tolerate.
Your financial goals also play a central role in asset allocation. Retirement planning, estate planning, saving to purchase real estate, and providing for younger generations are all goals that may require different types of financial planning.
One of the biggest influencing factors on time horizons and financial goals is age. That’s why determining one’s ideal asset allocation based on age has been a popular go-to method.
It’s called The 100 Rule, and it looks like this. Subtract your age from the number 100, and the answer is the percentage of your investment portfolio that you should dedicate to stocks.
For example, if you’re 30 years old, you would subtract 30 from 100 and get 70. The 100 Rule dictates that you should invest 70% of your assets in stocks. As you get older, this number gets smaller and you’ll end up investing less of your portfolio in the stock market.
This model follows the logic that you’ll want your portfolio to gradually become less aggressive as you get older and approach the time horizons of your investments. It’s also because stocks typically outperform other asset classes in the long run. This is also the guiding principle behind target-date funds.
Does The 100 Rule Work?
Everything changes, and that includes optimal investment strategies. One thing in particular that changes is life expectancy. People are simply living longer these days, and that has an impact on proper asset allocation.
Longer life expectancy means two things when it comes to retirement planning. One is that you’ll need a bigger nest egg to last you through retirement. The other is that your investments will have more time to outlast temporary downturns in the stock market.
For the above reason, plus the fact that U.S. Treasury bonds have much lower interest rates than they once did, many investment experts are suggesting a revised approach to asset allocation.
The primary difference in the revised approach is to keep a higher percentage of your assets as stocks for longer. Some call it the 110 or even 120 rule, where you subtract your age from one of these numbers instead of 100.
As we mentioned before, target-date funds follow the same principle. They automatically adjust the asset allocation in your portfolio as the target date approaches. They are one of the most common types of 401k options, so many people have these. They’re also available through many investment companies.
It’s important to note, though, that not all of these funds are created equal. While they all tune your portfolio to deliver as best as possible by the target date, they don’t all take the same approach. Some are much more aggressive than others, and those that are risk-averse would do best to find one that fits their risk tolerance.
A Word on Index Funds and Mutual Funds
Determining how much of your portfolio to invest in stocks is one thing, but it isn’t the finish line. After you’ve decided how much of your assets you’d like to allocate to stocks, you’ve still got to choose how you want to invest those assets.
Two options for investing in stocks are index funds and mutual funds. The advantages of index funds are that they are low maintenance. This is because they simply track a specific stock index. Low maintenance means that they come with less associated fees.
Mutual funds have their own benefits. They require more active management and can boost the diversity of your portfolio. There is the potential for higher gains because they are more actively managed, but the higher fees often mean that they are less cost-effective than their index-based counterparts.
One of the best ways to take things into your own hands is to become educated and to know what factors to consider when financial planning. Identifying your goals, time horizons, and risk tolerance is a great place to start.
The 100, 110, or 120 Rule may be a good place to start when attempting to figure out the ideal asset allocation for your portfolio because age certainly plays a role. But before you go and use a free asset allocation calculator on the internet to figure out what to do with your money, consider consulting the experts.
After educating yourself, the next best thing you can do is seek a trusted advisor that will help you navigate your financial situation and make the most of your assets.
We Can Help
There are few things that affect as many areas of your life as your wealth. Treat it with the attention it deserves and it will repay the favor. Whether you’re thinking about retirement or estate planning or want to use your wealth to provide for younger generations, proper wealth and asset management is what will make it happen.
At Saddock Wealth, we bring years of wealth management experience to the table and can guide you toward financial prosperity. Make sure your wealth is in the right hands and ready to grow in 2020. Schedule a meeting here, and we’ll discuss your best options.