Setting the right portfolio asset allocation is one of the key things you can do to ensure success with your investments. Sometimes, though, it’s harder than it sounds. Why? Well, there’s a lot to consider. You have to find the balance between risk and reward amongst equities/stocks (high risk, high reward), fixed-income/bonds (medium risk, medium reward) and cash (low risk, low reward) in your portfolio. Luckily, we can help. By following a few important rules, your financial goals will be within reach.
One rule you may have heard of is that the percentage of stocks in your portfolio should be equal to 100 minus your age. This is, if you are 45 years old, your portfolio should be 65% in stocks and 45% in bonds. The idea behind this is that someone who is younger can take more risk since they have a longer time horizon.
While this might be a good starting point, it doesn’t factor-in things like your goals, personal financial situation and your personality. Below, we explore several areas that will help you set an appropriate asset allocation.
Your Time Horizon
One thing that affects your ability to take risk is the time horizon associated with your goals. If your child is going to university next year, you don’t want to invest their tuition money in stock market in case it drops and doesn’t recover by the time the university mails the bill. On the other hand, if you are 20 years away from your retirement, you can probably afford to take more risk with your retirement savings than someone who is retiring next year.
Your Personal Financial Situation
You also need to look at your personal financial situation when assessing your ability to take risk. If you have a government job with a defined-benefit pension for life, your financial picture is rather predictable, allowing you to take more risk. If you are working for a temp agency though, your situation is less clear. You wouldn’t want to take a lot of risk with your investments if you don’t know if you’ll have a job next month.
Your “Need to Take Risks” VS “Ability To Take Risks”
If you are an 80-year-old retiree with a $5 million portfolio and are only withdrawing $40,000 a year from it for spending, you don’t need to take risk. Such a person has the ability to take risk thanks to their large portfolio and small spending habits, but they don’t need to. Why take on more risk and uncertainty than you may need to achieve your goals?
Your Willingness to Take Risks
Even if you have the ability and need to take risk, can your personality handle it? If you lie awake in bed at night after seeing that your portfolio dropped in value last month, the added stress may not be worth it for you. You have to find the right risk/reward trade-off that doesn’t increase the amount of worry in your life.