Asset Allocation by Age and Risk Tolerance
What percentage of your portfolio should be invested in stocks? In bonds? How
much should an investor hold in cash? Answering these questions is a process
known as asset allocation.
There are many ways to allocate assets in a portfolio. Perhaps the most basic
decision, however, is the consideration between stocks and bonds. Stocks offer
the potential for long-term growth. Over the past century, the stock market
has provided investors with an average annual return of better than 10 percent.
However, stocks can be volatile up 20 percent one year and down 20 percent
the next. Also, most stocks don't provide much in the way of income.
Bonds offer annual income, usually in excess of inflation. That's important
to retired people and others with limited sources of income. However, bonds
don't generally offer growth. Cash or money market funds may offer more safety and liquidity. However, returns are generally much lower
than stocks or bonds.
One way to determine the mix of stocks, bonds, and cash is simply to look
at age and life expectancy. In a person's early years, investment time horizons
are long and the volatility of stocks can more easily be tolerated. As a person
approaches retirement, he or she becomes more dependent on income from investments,
which would favor bonds.
However, retirement should not be the end of a person's investment horizon.
With life expectancies reaching into the 80s, it's quite common for a person
to live 20 or 30 years beyond retirement. As a result, it's still important
to own some stocks for growth. Investment expert Chuck Carlson, author of the
book Eight Steps to Seven Figures, suggests subtracting age from 110
to determine the percentage of stocks that should be held in a portfolio. For
example, a 50-year old would hold 60 percent of his or her investment portfolio
in stocks. The remainder would be divided between bonds and cash.
But it's not that simple. The asset-allocation decision is also dependent
upon a person's attitude about risk. There are some 60-year-olds who prefer
to concentrate their holdings in stocks because they have a large portfolio,
few financial responsibilities, and don't mind the volatility. On the other
hand, there are some 40-year-olds who are not comfortable with the ups and downs
of the stock market. Attitude toward risk is a very personal decision.
Stock funds should only be considered for long-term goals as values fluctuate
in response to the activities of individual companies and general market and economic
conditions. Bond fund values fluctuate in response to the financial condition
of individual issuers, general market and economic conditions, and changes in
interest rates. In general, when interest rates rise, bond fund values fall and
investors may lose principal value. Some funds, including non-diversified funds
and funds investing in international securities, high yield bonds, small- and
mid-cap stocks and/or more volatile segments of the economy, entail additional
risk and may not be appropriate for all investors. Consult a Fund's prospectus
for additional information on these and other risks.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.