All investors eventually learn the golden rule of investing: diversify, diversify, diversify. Still, achieving the best mix of stocks, bonds and other assets is no easy feat. Fortunately, you can turn to several ways for getting your portfolio right, including asset allocation by age.
You want diversity in your portfolio to avoid putting all your investments in one place. If you only have one investment, you can imagine what happens if it fails. That’s what the phrase “don’t put all your eggs in one basket” means – you could lose everything if you put all your efforts in one place.
Mixing up the types of investments in your portfolio gives you a sort of cushion in case something happens to one of them. Diversifying significantly reduces your risk. And the more you diversify, the lower your risk.
Diversifying any old way is better than not diversifying at all. But most investors want to get the most out of their money. So, it’s important to think about exactly how you want to diversify.
With a good strategy in hand, you can make your money work for you – toward your own goals.
In this article, you’ll learn:
- How Does Asset Allocation Work?
- Why is Asset Allocation So Important?
- What is Asset Allocation by Age?
- What are the Benefits of Asset Allocation by Age?
- Why Age is Not the Only Factor for Investment Decisions
- What Else Should I Consider with My Portfolio Mix?
- What are the 3 Type of Investors?
- What is a Good Asset Allocation Strategy?
How Does Asset Allocation Work?
When you “allocate” your assets, you divide them up into different assets or securities. With this investing technique, you aim for a healthy mix of stocks, bonds, cash, and real estate or other assets.
Each asset has a different degree of risk. And they’re affected by different factors.
Stocks are considered higher risk than bonds. And cash has virtually no risk. Of course, cash offers no gains, either. Real estate helps diversify a portfolio because the value of real estate affected by different forces than stocks and bonds – it’s not as tied to the broader market.
Why is Asset Allocation So Important?
Asset allocation is a way to balance your risk versus your targeted growth. It’s important to help investors meet their financial goals, whether they are to get income during retirement or to save for a down payment on a home.
Traditionally, stocks have been considered a growth component of a portfolio. Bonds are more of an investment for safety, or principal protection, and modest gains.
Of course, all investments have some risk. But some are known to be higher risk than others.
Many investors also use exchange-traded funds (ETFs) to reduce risk. These funds hold several assets that can track a group of stocks or bonds. So, with ETFs, you are actually holding more than one asset at once. They provide built-in diversity.
What is Asset Allocation by Age?
Your age can be one of the best guides for how to allocate your assets. While everyone has a unique life situation, we all have some similarities with financial goals at each age.
Determining your asset allocation by age can be a great foundation for a plan to diversify.
No matter if you’re just staring to invest, or if you are already in retirement – or anywhere on life’s path in between – you can craft the right mix in your investments.
What are the Benefits of Asset Allocation by Age?
Many financial advisors recommend that you adjust your asset allocation by age as one of the factors in choosing your investments.
They start with the assumption that the younger you are, the more risk you can take on. That’s because if you’re very young, you have plenty of time for your investments to weather the ups and downs of the market. So younger investors can take on riskier investments that could lead to higher gains.
When you’re older, you generally want to take on less risk. That’s because your investments have less time to recover from a downturn. If you’re depending on your investments for retirement income, you certainly don’t want to lose them.
Portfolios that take on more risk are considered more aggressive. And those that take on less risk are considered more conservative. So, younger investors tend to go for more aggressive portfolios while older investors tend to have more conservative holdings.
Why Age is Not the Only Factor for Investment Decisions
Even making asset allocation by age is not a black and white strategy because so many factors can go into what makes the best portfolio for you.
For example, people who are in retirement don’t necessarily always want a conservative portfolio. They may be planning to pass their assets on to heirs. In that case, their investing horizon (timeline) would be much longer. So, they may want to keep their money in more aggressive investments that have the potential for higher gains.
And aggressive investment strategies might not always be in the best interest of younger people. For some young investors, retirement savings isn’t necessarily the immediate financial goal.
They may be saving for a house and need to access their funds in the short term, not decades down the line. In that case, a conservative investment strategy may be more recommendable so that they do not risk losing their assets within their shorter investing horizon.
What Else Should I Consider with my Portfolio Mix?
Age is a good indicator of how you should design your portfolio, but it’s certainly not the only factor.
When you’re deciding the right mix of investments you should also take into account:
- Financial goals. Are you investing toward retirement? A downpayment for a first home? Your child’s education?
- Investing horizon. When will you need or want to use the money in your portfolio? If you need it sooner, your investing horizon is shorter. And if you are saving for the long-term, your investing horizon is longer.
- Risk tolerance. How worried are you about losses in your portfolio? No one likes to lose money, but some are willing to take on more risk than others.
- Investment goals. What do you want your investments to do for you? Provide income, such as through dividends? Or focus on growth?
- Income sources. Will your investments provide your main income source? Or can you depend on other income sources? Will your income change in the near future?
Your portfolio can better weather the market’s ups and downs if your asset allocation takes your whole financial picture into account.
What are the 3 Type of Investors?
Your investment identity can usually be classified by one of three categories: aggressive, moderate or conservative. It’s based on factors like your financial goals, investing horizon, risk tolerance and age. The type of investor you are will play a role in how you allocate your portfolio.
- Aggressive: Aggressive investors take on more risk in the hopes of scoring more gains. They could lose bigger, but they could also win bigger. If your investing horizon is longer and your investment goals are growth, an aggressive strategy may suit you.
- Moderate: A moderate investor does want to pursue significant gains, but is not willing to take on as much risk as an aggressive investor. They will take on more risk than a conservative investor.
- Conservative: A conservative investor’s top priority is not to lose money. Their second goal is to gain money. With that in mind, they will take on very little risk. You may want a more conservative strategy if your investing horizon is shorter, or if your risk tolerance is very low.
Typically, younger investors will tend toward aggressive portfolios while older investors will tend toward conservative portfolios.
What is a Good Asset Allocation Strategy?
When it comes to setting a good strategy for allocating your assets, the “set it and forget it” method is not a great idea. Instead, financial advisors recommend that you adapt your allocation strategy over time as your financial goals, investing horizons and risk.
The “set it and forget it” style is when you make your investment choices and then step away until you are ready to access your funds.
While you might not want to monitor your portfolio daily, you should prepare to shift your allocations as your investment needs change. You want your investments to be working for your current life stage and toward your ultimate goals.
So, for example, as younger investors age, they may want to shift some of their higher-risk stocks into bonds or more conservative assets.
Aging aside, you should plan to revisit your portfolio on occasion simply because the market changes. Your portfolio may, for example, shift to hold more value in stocks if the stock market rises.
You can make periodic rebalancing adjustments to match your original asset allocation plan. If you’re not interest in rebalancing on your own, you can invest with a robo-advisor, which makes adjustments in your portfolio allocation automatically based on the terms you set. Professional managers can provide similar services.
The Bottom Line
Don’t put off reviewing your investments and determining the best asset mix for you. The sooner you put your investing plan in place, the sooner it can start working to help you meet your financial goals.
For more financial guidance, turn to a professional financial advisor who can work with you to help tailor your portfolio to your own situation. After all, having a good asset allocation strategy in place can be crucial to your financial future.