Choosing the asset allocation can be a challenging task. But it is the most important part of investing. Asset allocation is the amount you invest in various classes of assets like stocks, real estate, bonds and cash. Here are some tips you should keep in mind regarding asset allocation.
- You get higher expected returns from high-risk assets. These risks can result in sharp declines in portfolio value instead of gains. As the level of risk and return on investment is directly related, it is important to create your balance to take a risk and with your ability to withstand the fluctuating market.
- If you are young, then you have many years of compounding in future, so your risk is low. But your size of the portfolio is probably small, and so you have to go a long way to reach your retirement goals. So, young people often want to take a high risk to accumulate a fund for their retirement.
- If you are closer to retirement and you, think that you have not saved enough money. Then you will be opted to take higher risks to get higher returns. On the other hand, if you have achieved your financial goals, you need to take less risk.
- According to academic research, you shouldn’t withdraw more than 4% of your portfolio value every year in retirement if you want to have your portfolio last over a 30-year retirement.
- The ability of a person to take risk depends on the person’s personal tolerance for withstanding a down market without feeling any stress.
- The worst thing to do is selling in the face of a market decline. This could result in a permanent loss.
- You should keep in mind the following rules of thumb:
If you are 40 years old, you should use a 60/40 (equity/bond) allocation.
Consider 110 minus your age in equities. That is, if you are 40 years old, then 110-40 years old = 70/30 (equity/bond) asset allocation.
Consider 120 minus your age in equities. That is, 120-40 years od = 80/20 (equity/bond allocation).
Research shows that asset allocation is responsible for more than 90% of portfolio returns. So, it is more important than particular fund selection.