YOUR MIX OF STOCKS, bonds, cash and alternative investments will be driven by your goals and individual circumstances. Still, it’s helpful to have some guidelines. Consider two approaches.
First, there’s the popular rule of thumb that says that, for retirement savings, you should take 100 and subtract your age. Whatever the result, that’s the percentage of your investment portfolio that you should put in stocks. For instance, the rule suggests a 30-year-old should have 70% in stocks.
As rules of thumb go, it isn’t bad. But you might tweak it. Those in their 20s and 30s could probably have as much as 100% in stocks, though a 90% maximum might be more prudent. Why? By keeping a minimum 10% in bonds, you can notably reduce volatility without putting much of a dent in returns. Meanwhile, among retirees, stocks should probably be pegged at a minimum 30%. If you have less than that, you leave yourself vulnerable to long-run inflation. Indeed, with the right portfolio design, a 50% or 60% stock allocation may make more sense for retirees.
What’s the second approach? As a starting point, aim for 60% of your retirement nest egg in stocks, with your nest egg defined as its current value plus future savings. Those future savings represent cash that’s yet to be invested and hence you can view them as part of your portfolio’s conservative holdings, along with your bonds.
No future savings? You should have a maximum 60% in stocks. Just entered the work world? Let’s say you’re age 25 with a $10,000 portfolio that’s entirely in stocks. Risky? Suppose that, over the next 40 years, you expect to save $5,000 a year toward retirement, or $200,000 total. Result: If you combine your $10,000 current portfolio with your $200,000 in future savings, your $10,000 in stocks represents less than 5% of the $210,000 total. In fact, if you have a strong stomach for market volatility, you could probably hold a 100% stock portfolio into your early 40s and still be below 60% stocks, once you figure in future savings.
What about alternative investments? Here at HumbleDollar, we don’t think they’re a necessary part of a portfolio. But if you want a position in a mix of, say, gold stocks and real estate investment trusts, consider capping that position at 10% of your portfolio, no matter what your age.
Finally, cash investments make sense for money you plan to spend in the near future, such as savings earmarked for a house down payment or spending money for the next five years of your retirement. But cash isn’t a necessary part of a long-term investment portfolio. If you’re inclined to hold cash for the long haul, consider instead a high-quality short-term bond fund or your 401(k) plan’s stable-value fund. Both should offer somewhat higher yields than a savings account or a money-market mutual fund.
Settled on your portfolio’s target asset allocation? It’s time for the next step: deciding how you will diversify within these asset classes.
Next: Step 3: Diversify
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