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May 25, 2024 — 10 min read

Asset Allocation by Age: A Comprehensive Guide for Every Life Stage

Josh Pigford


Josh Pigford

Asset allocation is a fundamental concept in investing, where an individual divides their investment portfolio among various asset categories, such as equities, fixed-income assets, and cash equivalents. This strategic division is aimed at balancing the risk and rewards in line with one's financial goals, risk tolerance, and investment horizon. The three primary asset classes involved in this process are equities, fixed income, and cash and cash equivalents, each carrying distinct risks and potential returns and behaving differently over time.

What is Asset Allocation?

Asset allocation is not about a one-size-fits-all formula but is a personalized strategy. It is considered one of the most crucial decisions investors make, significantly influencing investment outcomes. The procedure involves not just the initial decision of how to distribute investments among stocks, bonds, and cash but also the selection of individual securities within these asset classes. This strategic distribution is influenced by distinct goals, such as saving for a car in the near term versus saving for retirement decades away, with each objective necessitating a different asset mix.

The Importance of Diversification

Diversification is a key principle in asset allocation, aimed at reducing risk without considerably sacrificing returns. It involves spreading investments across various asset classes, sectors, industries, and even geographic locations to mitigate the impact of poor performance in any single investment. By diversifying, investors can achieve a more consistent overall return, as the negative performance of one investment can potentially be offset by better performance in another. A well-diversified portfolio should be diversified at two levels: between asset categories and within asset categories, ensuring investments in segments of each asset category may perform differently under different market conditions.

Implementing a diversified, multi-asset class portfolio typically involves two steps: deciding on the long-term strategic exposures to different asset classes and then selecting specific investments to achieve these targeted allocations. This process translates an investor's circumstances, objectives, and constraints into an appropriate portfolio or portfolios for achieving their goals within their risk tolerance. Diversification, while not guaranteeing against loss, is widely regarded as the most important component of reaching long-range financial goals while minimizing risk.

Adjusting Asset Allocation by Age

In Your 20s and 30s

  1. Start Investing Early: Despite potential financial challenges such as student loans, individuals in their 20s should begin investing as soon as possible. Even if unable to contribute the recommended 10%, any amount invested in a 401(k) or an IRA can significantly benefit from compound interest over time.
  2. Prioritize Growth Stocks: Given the long investment horizon, a focus on aggressive growth stocks over slow-growing assets like bonds is advisable due to the ability to absorb market changes.
  3. Increase Investment in Your 30s: If investment was delayed in the 20s, the 30s are critical for starting or increasing contributions to retirement savings, aiming for 10% to 15% of income.

In Your 40s and 50s

  1. Maximize Contributions: Continue prioritizing retirement savings, including maximizing 401(k) contributions to receive company matches and maxing out IRAs. It's also time to consider adding bonds for diversification and safety.
  2. Catch-Up Contributions: For those starting late or looking to bolster their savings, the IRS allows additional contributions for individuals 50 and older. This includes an extra $7,500 per year to a 401(k) and increased limits for IRAs.
  3. Rebalance Portfolio: As retirement approaches, gradually shifting towards more stable investments like bonds and money markets can help protect savings while still allowing for growth.

In Your 60s and Beyond

  1. Shift Focus to Income: Transitioning from growth to income generation in retirement is crucial. Maintaining some stocks for dividend income while increasing bond holdings can provide a balanced approach to preserving capital and generating income.
  2. Consider Fixed-Income Investments: As market volatility can impact retirement timing, having a portion of the portfolio in fixed-income assets like bonds or cash can provide income during downturns without needing to sell stocks at a loss.
  3. Retirement Drawdown Strategy: Implementing a strategy for withdrawing assets in retirement, such as the 4% rule adjusted for inflation, is essential for managing longevity risk and ensuring funds last through retirement.

By following these age-specific strategies, individuals can adjust their asset allocation to balance growth, income, and security throughout their financial journey, ultimately striving for a comfortable and secure retirement.

Considering Risk Tolerance

Rules of Thumb (100 Minus Age, 110 Minus Age)

Understanding how much risk one should take with investments often involves using age-based rules of thumb. These guidelines suggest that individuals subtract their age from a baseline number to determine the percentage of their investment portfolio that should be held in stocks. For example, the Rule of 100 suggests that a 40-year-old might keep 60% of their portfolio in stocks, with the remainder in less volatile investments like bonds or cash. However, as life expectancy increases and retirement years potentially extend, many financial advisors recommend adjusting this rule to 110 or even 120 minus the age, allowing for a higher proportion of stocks in the portfolio to potentially increase returns over a longer period.

Individual Risk Appetite

The individual's comfort with risk, or risk tolerance, plays a critical role in shaping their investment strategy. Those with a higher risk tolerance may be comfortable watching the value of their investments fluctuate and may choose to allocate a significant portion of their portfolio to more volatile assets such as individual stocks, private equity, hedge funds, cryptocurrency, and real estate. Conversely, individuals who experience anxiety during market downturns may prefer a more conservative approach, opting for a higher percentage of bonds and cash equivalents to mitigate potential losses.

It is essential for investors to assess their financial goals, time horizon until retirement, and emotional capacity for handling market volatility to tailor their asset allocation effectively. This personalized approach helps ensure that the investment strategy aligns with both their financial needs and their ability to withstand market fluctuations, thereby supporting a more secure financial future.

Tips for Effective Asset Allocation

Avoiding Common Mistakes

  1. Not Having a Plan: Investors should start by identifying the purpose and timeline of their investment. Whether it's for a short-term goal like a down payment on a house or a long-term objective like retirement, defining these aspects helps in determining the appropriate risk level and asset allocation.
  2. Balancing Risk: Avoiding the extremes of being too aggressive or too conservative is crucial. Utilizing a risk tolerance questionnaire can align investments with one's comfort level with risk, ensuring a balanced approach that neither disappoints in growth nor causes undue stress during market downturns.
  3. Diversification: Concentrated positions in a single stock or sector can lead to significant losses if the market turns. Diversification across various asset classes and sectors can mitigate this risk. The principle of not putting all eggs in one basket applies here, emphasizing the importance of spreading investments.
  4. Comprehensive Asset Choices: Beyond just stocks and bonds, considering various categories within these asset classes, such as value or growth stocks, small-cap or large-cap, and international or domestic investments, can enhance returns. The choice between these should reflect one's asset allocation model, whether aggressive or conservative.

Using Tools and Resources

  1. Online Calculators and Questionnaires: These tools can provide a starting point for determining an appropriate asset allocation by factoring in age, assets, retirement needs, and risk tolerance. However, the accuracy of these tools depends on the quality of the information provided.
  2. Professional Advice: Seeking the guidance of a financial advisor can offer personalized strategies that online tools may not fully capture. Advisors can provide insights tailored to individual circumstances and preferences, enhancing the effectiveness of asset allocation.
  3. Model Portfolios: Many investment firms offer model portfolios ranging from conservative to very aggressive. These can serve as benchmarks or starting points for investors, which can then be adjusted according to personal goals and risk tolerance.
  4. Periodic Reviews and Rebalancing: Asset allocation is not a set-it-and-forget-it strategy. Regular reviews and adjustments are necessary to respond to life changes, financial goals, and market conditions. Rebalancing ensures that the portfolio remains aligned with one's investment objectives and risk profile.

By adhering to these tips and leveraging available tools and resources, investors can navigate the complexities of asset allocation, optimizing their portfolios for a balance of risk and return that suits their individual needs and goals.


What is the Ideal Asset Allocation Strategy as You Age?

The widely accepted strategy for asset allocation by age suggests that the percentage of stocks in your portfolio should be 100 minus your current age. For example, at age 40, 60% of your portfolio would be in stocks. However, with increasing life expectancies, adjusting this formula to 110 or even 120 minus your age could be more fitting to ensure your investments last.

How Does Age Influence Your Investment Mix?

According to a simple rule of thumb for asset allocation, you should subtract your age from 100 to determine your equity allocation. This implies that as you age, there should be a gradual shift in your investment strategy from equity funds to debt funds and fixed-income investments, adjusting for risk and ensuring financial stability.

What Does the 120-Age Rule Entail for Investors?

The 120-age rule is a guideline that suggests investors maintain a higher proportion of their portfolio in riskier investments, like stocks, for a longer duration. This strategy is aimed at accumulating greater wealth over time, a necessity considering the extended average lifespan of retirees today.

Can You Explain the 110 Age Rule for Asset Allocation?

The 110 age rule offers a method for age-based asset allocation, advising that you subtract your current age from 110 to find the ideal percentage of your portfolio to invest in stocks. For instance, a 30-year-old would allocate 80% (110 - 30 = 80) of their portfolio to stocks, following this guideline to balance risk and growth potential as they age.

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