Working Toward a Goal:
Asset Allocation
by
Charles Lamson
Portfolio Components
Asset allocation is about spreading risk over different asset classes to even out the peaks and valleys. Most financial professionals feel that your portfolio should consist of a mix of bonds and stocks. Some would add cash to the mix but most would not.
The obvious questions here are
The answer, like most answers to investing questions, is: "It depends." It depends on your age and risk tolerance. A young, aggressive investor will look at these questions quite differently than a middle-aged conservative investor.
It might be helpful to look at the problem from an age/risk perspective. Again, we are assuming that the investment goal is funding retirement by age 65.
We will look at age groups starting with the youngest and working forward. Each age group will have three levels of risk tolerance: conservative, moderate, and aggressive with suggestions for each. There is no official asset allocation formula, so consider these suggestions as just that: a starting point for your own thinking.
Age 20-30
It may be hard to think seriously about retirement at this age, but you could not pick a better time to start. Not only will you almost certainly build a substantial nest egg, but you will get in the habit of investing that will serve you well the rest of your life.
Conservative Portfolio
A conservative approach at this age suggests a stock/bond mix for long-term growth and stability. An additional consideration is that there will not be a lot of money invested in this period, so mutual funds make more sense than individual issues.
Moderate Portfolio
A more aggressive approach might stay with a stock/bond mix, but change the portions somewhat.
Aggressive Portfolio
Our young lion wants to roar; so we drop bonds from the mix completely.
Age 30-40
For many of us this is the age in which we begin to settle down and start thinking about our future. Retirement is still a long way off but not so far that it is off our radar screen altogether.
Conservative Portfolio
Our conservative investor can stand put or if she believes the stock market is looking shakey, move more assets into long-term bonds.
Moderate Portfolio
Our moderate friend is happy with the mix, but just to be on the safe side, ups the percentage of bonds.
Aggressive Portfolio
Our young lion still wants to roar but begins to understand the danger of staying heavily invested in one area (small-cap stocks).
Age 40-50
As we enter the years of our peak earning capacity, retirement begins to seem like a not-to-distant hill looming larger and larger.
Conservative Portfolio
Our conservative investor hears retirement calling more loudly than most. She grows more nervous about stocks and moves more assets into long-term bonds.
Moderate Portfolio
Our moderate friend is becoming nervous about the stock/bond ratio and moves to up the bond component at the expense of the large-cap growth fund.
Aggressive Portfolio
Our young lion realizes he is not a young lion anymore, but wants to stay heavily invested in stocks as is prudent. His move into bonds discards the fund notion and buys bonds directly for a better yield even though the risk is higher.
Age 50-60
These are the years we set the stage for requirement, getting our ducks in a row and guarding against any fourth quarter surprises by the market.
Conservative Portfolio
Our conservative investor is focusing on calculating what her living expenses will be and how much she will have coming in between Social Security and her retirement. The focus is shifting to income and capital preservation. She will stay in equities but will move out of an index fund and into solid income stocks like utilities. At the same time, she will slowly shift out of a bond fund and into individual bonds (10 years or more) that begin maturing at retirement. At the end of this period, her portfolio looks like this:
Moderate Portfolio
Our moderate friend also begins moving toward income and away from growth, but not completely. Foreign stocks look too unstable, so they get dropped. He also begins shifting away from a bond index fund and into high-quality individual bonds.
Age 60-??
Even though we may not retire until 65 (and many people are continuing to work after 65), we are in a retirement mode at this point with our investments.
Conservative Portfolio
Our conservative investor continues her shift to current income and capital preservation. However, she is aware that being too conservative may cause her to outlive her money.
Moderate Portfolio
Our moderate friend begins the shift to a heavier emphasis on income and away from growth.
Aggressive Portfolio
Our now not-so-agile young lion finds golf more interesting than investing but still keeps his toe in the water.
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 292-297*
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