At my day job (being a financial planner), I take care of the investment of many individuals. While most of them are concerned about their yield or about the latest moves done by the portfolio manager, almost all of them ignore or diminish the importance of asset allocation. I’ve written about etf asset allocation and how building your own asset allocation model is important. In fact, the asset allocation (e.g. diversification) is the most important factor that explains the yield you are getting.
Asset allocation by age
Unfortunately, there are no magic tricks to find the perfect asset allocation. Some say that you are better off with index ETFs while others will preach for a more balanced approach with a mix of secure bonds and equities. The perfect asset allocation is not the one which will make you rich but rather the one that will fit your investor profile. One of the key factors in determining your investing profile is your age. While it’s not the only factor to take into consideration, you can usually manage your asset allocation according to your age:
Asset Allocation from 18 to 35
While you should not be having much money to invest during this period, this is where you should risk the most. Technically, you should not need the money you invest for retirement for a good 30 years. This is the perfect time horizon for an investor.
I would then think that an asset allocation with 90% to 100% in stocks would be ideal. You can invest through mutual funds or index ETFs as well as trying to build your own stock portfolio. Why should you select such an aggressive asset allocation? Simply because it will be the type of portfolio with the highest expected yield over time. Investing in bonds at such early age will minimize your profit expectancy for nothing. If you are inexperience, I would suggest you leave the temptation of being your own broker and you adopt a “coach potato” approach through ETF investing.
Asset Allocation from 36 to 50
This is usually the time of your life where you get a better job (therefore better salary!) but also where you get most of your expenses. Several people in their 30’s will find the perfect one and fund a family. With the family often comes 2 cars and a house… so a lot of expenses!
You probably don’t have much time to take care of your asset allocation and you might not have much money to invest (then again!). however, it is important to start investing as soon as possible and if you have not started yet while being in your 30’s, you will be running late to fund your retirement portfolio.
Since you might be a little bit concerned about your investment fluctuation since you have several financial obligations, I think that having a small portion of your portfolio into bonds should be a good thing.
Try to aim for an asset allocation including about 75% of equity and 25% of bonds. At your age, you still can afford a lot of risk and you should not be shy to take them. The 25% in your asset allocation will smooth your investment returns during important crisis but won’t slow down too much.
Asset Allocation from 51 to 65
During this period, you will be about to retire and definitely be thinking of your withdrawal strategy. However, it’s not a reason to freak out and secure your asset allocation to the maximum either!
Since you won’t be withdrawing much of your investment during at that age, you can still handle some market fluctuations. Going from a growth to a more balanced asset allocation seem logical. Therefore, a 50%/50% asset allocation approach would allow you to earn some decent investment returns while not suffering too much during market crashes.
At that age, the last thing you want is to see your investments going down by 20% or more!
Asset Allocation from 66 and older
This is for sure, you will be retired during this period of your life. If you have been investing throughout your whole life, you should be sitting on a solid nest egg. There are no reasons why you should risk in the name of higher returns.
A more secure asset allocation showing a 75% to 100% bond/cd’s portfolio is reasonable. You will simply have to manage your withdrawal schedule and avoid to have too much money concentrated into one bond. I would also leave the world of ETF’s to concentrate on CD and bond holdings.
Final thoughts on asset allocation by age
If there was only age to manage when we are talking about asset allocation, things would be pretty easy! However, this is far from being that simple. In fact, age is only a mathematical data that doesn’t take into consideration your risk tolerance. You might be young enough to support a big market drop as you will have time to play with you to gain it back, if you are about to have a heart attack when the market goes down by 5%, you won’t last until your retirement!
On the other side, I personally think that I will maintain a very high level of stocks until I retire. I don’t really mind about market fluctuation and I believe I can earn higher returns by staying invested in the market. I must also admit that I have a good portion of my portfolio which is invested in dividend which are less risky than “regular” stocks.