Asset allocation is a critical part of any investment strategy. It’s all about dividing your investment portfolio among asset classes, like stocks, bonds, and cash. Each class comes with its own level of risk and potential returns, and understanding how to balance them can significantly impact your financial future.
In this post, I’ll show you how you can optimize your asset allocation as you age to ensure you’re always investing smartly, and I’ll also cover mutual funds at the end of the post.
Why Asset Allocation Matters
Think of asset allocation as a strategy to manage risk. When you’re young, you have time on your side. This means you can afford to take on more risk because you have years to ride out any market downturns. As you age, your investment strategy should shift towards preserving what you’ve built, which typically means reducing risk.
Sounds simple, but let’s get practical. How does this actually work? Let’s break down what your mix of different investments might look like through the years.
In Your 20s and 30s: Go Bold with Stocks
When you’re in your twenties and thirties, you’re at the perfect stage to begin investing in stocks and stock funds with a heavy hand. Why? Because if the market takes a hit, you have the luxury of time to recover. Stocks have historically offered the best long-term returns compared to other asset classes. So, being aggressive with your asset allocation now can pay off big later. Compound interest is one of your most powerful tools financially, and the sooner you begin investing the more you benefit.
So, having said that, I’d suggest allocating 80-90% of your portfolio to stocks at this age. I can already hear you say ‘this sounds risky’, but you’ve got decades ahead of you; the rollercoaster which is the stock market will balance out and give good long-term returns. A tip if you’re just starting out is to begin with low-cost index funds, they’re easy to manage and give broad exposure to the stock market.
In Your 40s and 50s: Start Dialing Down the Risk
As you move into your forties and fifties, it’s time to start rebalancing your portfolio to protect against potential losses. This doesn’t mean abandoning stocks altogether—far from it. You still want growth, but with a bit more security. As with many things in life, you want to be a little less gung-ho once you’re out of your twenties and thirties.
So, what does that mean? I’d suggest a shift towards a mix of 60-70% stocks and 30-40% bonds. Bonds are less volatile than stocks and can provide a safety net. Review your investment portfolio annually and adjust your asset allocation to ensure it aligns with your long-term goals and risk tolerance. This means consistent tweaking of your portfolio rather than wholesale changes – avoid hitting the panic button anytime there’s a downturn.
In Your 60s and Beyond: Prioritize Preservation
As retirement approaches, preserving the wealth you’ve built becomes the priority. The closer you get to needing your investment for day-to-day living expenses, the less you can afford to take risks. By this point my advice is to move towards a mix of 50-60% bonds, 30-40% stocks, and consider keeping some cash on hand for emergencies.You’re more likely to need your cash quickly at this age, be it for unexpected medical bills or whatever else, and withdrawing investments can take time.
Look into target-date funds, which automatically adjust your asset allocation as you age. They’re a convenient, set-it-and-forget-it option that can help you maintain the right balance.Of course, be sure to enjoy your retirement, too: reap the rewards of smart financial decisions over the decades.
In a recent episode of my podcast, I spoke to Adrienne and Rob – a couple who had spent years building a hefty net worth, but were reluctant to spend even when it’d benefit them. Despite sitting on almost $2 million dollars in assets, they didn’t want to pay for a financial advisor, something which would’ve alleviated the stress they felt about managing their money:
[00:19:32] Ramit: All right.
[00:21:06] Adrienne: Debt, 0.
[00:21:08] Rob: Great. Total net worth?
[00:21:11] Adrienne: Yeah, 1,989,542.
[00:21:19] Ramit: Nice. All right. So just under 2-million-dollar net worth. What do you think about that?
[00:21:26] Rob: I think it’s good.
[00:21:27] Ramit: Mm-hmm. Cool. Rob, what do you think?
[00:21:32] Rob: I think it’s great, and I’m hoping it lasts for 30 years.
[00:21:37] Ramit: That’s the primary question. Will this money last for the rest of our lives?
[00:21:42] Rob: Yeah.
[00:21:44] Ramit: And y’all thought if we come on the show, we’ll get Ramit Sethi to give us an answer. Yes or no. And then once we know, we’ll hopefully feel better, right?
[00:21:55] Rob: Yes.
[00:21:56] Ramit: Okay. Do you still believe that? That’s the actual question that you need help with.
[00:22:05] Rob: I think that’s one small piece of what we need help with.
[00:22:08] Ramit: If that were the question keeping you up at night, there are plenty of ways to
get that question answered. Right? You didn’t have to wait to talk to me. What would be some of
the other ways to get that question answered?
[00:22:20] Adrienne: Rob went on to the Bogleheads. Is it Bogleheads?
[00:22:25] Ramit: Yes.
[00:22:27] Adrienne: And asked that question, and they said, yeah, it should work out.
[00:22:31] Ramit: All right. So?
[00:22:34] Rob: I’ve read a ton of financial blogs that talk about the 4% rule.
[00:22:39] Ramit: Why are you guys not spending money on solving your problems? I’m really confused. This is a money problem. It’s a math problem. It’s like, let me pay someone to model this out for me. Just tell me the answer and tell me the variables. That’s it. This is a classic financial advisor problem. And you almost never hear me saying like, get a financial advisor, but like, this is the clearest use of a financial advisor ever.
The answer was right in front of them. They could’ve been spending more money on solving their problems, in this case a financial advisor – it’s not something I recommend often, but their position was one of the clearest use cases I’ve seen. What they needed was someone to sit and model their finances for them, but it’s not something they’d been considering; remember, sometimes it’s about spending the wealth you’ve built, not just sitting on it.
The Importance of Consistency (regardless of your age)
No matter your age, the most important rule in investing is consistency. The worst thing you can do is nothing. Start investing early, even if it’s a small amount, and keep it up. The power of compound interest is on your side, but only if you stay in the game and join it early.
To make the process of regular investing easier, consider setting up automatic contributions to your investment accounts. Automating your investments means that a fixed amount of money will be transferred from your bank account to your investment account on a regular basis, without you having to actively think about it. This “set it and forget it” approach not only removes the hassle of remembering to invest but also helps you avoid the temptation of skipping a contribution.
Look at it this way: we’ve all been there, choosing whether to invest this month or spend on some lavish luxury item. By automating your investments, you ensure that you’re consistently putting money to work, taking advantage of the power of compounding, and building wealth over time with minimal effort, without the temptation of spending it on something frivolous.
Understanding Mutual Funds
Now that we’ve looked at asset allocation by age, let’s take a moment to consider mutual funds. They’re an investment vehicle used to pool money from multiple investors to purchase a diverse portfolio of stocks and bonds. Over the years they’ve become an increasingly popular option in the U.S. and abroad, but might not be as profitable as they seem at first glance.
Now, while mutual funds can be a good option for those who want a hands-off approach, you need to be wary of the fees. Actively managed mutual funds often charge high fees that can eat into your returns. Instead, consider low-cost index funds or ETFs, which offer similar diversification without the high costs. The reality is that 75% of actively managed mutual funds fail to beat the market. You’re better off sticking with funds that track the market.
For example, there are large-cap, mid-cap, and small-cap stock mutual funds, but also mutual funds that focus on biotechnology, communication, and even European or Asian stocks.
Mutual funds are extremely popular because they allow you to pick one fund that contains different stocks and not worry about putting too many eggs in one basket (as you likely would if you bought individual stocks), monitoring prospectuses, or keeping up with industry news. The funds provide instant diversification because they hold many different stocks.
Most people’s first encounter with mutual funds is through their 401(k), where they choose from a bewildering array of options. It’s like being a kid in a candy store, except you don’t know what candy you like and you’re risking your life savings instead of pennies. You buy shares of the fund, and the fund’s manager picks the stocks he or she thinks will yield the best return. Keep in mind that mutual funds are incredibly useful financial tools—over the past eighty-five years, they have proven to be very popular and extremely profitable.
But that’s just one side of the story…
The Pros and Cons of Mutual Funds
Compared with other investments, mutual funds have been a cash cow for Wall Street. That’s because in exchange for “active management” (having an expert choose a fund’s stocks), the financial companies charge big fat fees (also known as expense ratios).
These fees eat a hole in your returns. For what? For nothing! You don’t need to pay that! Sure, there are some low-fee funds out there, but most mutual funds have high expense ratios. Even the low-fee funds are taking a slice of your pie for little justification.
Now, I don’t fault the financial companies for selling mutual funds. They got average Americans to invest, and, even after fees, mutual funds are an excellent investment choice compared with doing nothing. But things have changed, and there are more and better options to consider.
Don’t get me wrong, there are advantages to a mutual fund. The hands-off approach means an expert money manager makes investment decisions for you. Mutual funds hold many varied stocks, so if one company tanks, your fund doesn’t go down with it. That’s a common mistake often made by individuals investing their cash – overloading in a ‘too-good-to-be-true’ stock which turns out to be exactly that.
But, let’s look at the other side. Annual fees can equal tens of thousands of dollars or more over the lifetime of an investment by using expense ratios, front-end loads, and back-end loads (worthless sales charges that add nothing to your returns) —all tricky ways to make mutual funds more money. At the end of the day, they’re looking to make as much money as possible from your investments: even if it doesn’t benefit you whatsoever.
Also, if you invest in two mutual funds, they may overlap in investments, meaning you may not really be as diversified as you think. Worst of all, you’re paying an “expert” to manage your money, and 75 percent of them do not beat the market. Any bookmaker will tell you that a 75% chance of losing is not good odds, so why accept them here?
More than anything, you must be intentional with your money. It’s the most important thing you’ll ever do.
Conclusion
Your asset allocation is going to change as you age. The time to take risks is when you’re younger: those in their twenties and thirties have plenty of time to take losses, knowing that the stock market will balance itself out over time. As you get older, you should increase your investment in safe assets – usually, this means reallocating into bonds, which are traditionally a safer bet. Your asset allocation is something you’ll constantly be tweaking throughout your life.
One of the most prevalent forms of asset management is mutual funds, but remember, while they’re popular because of their convenience, actively managed mutual funds are, by definition, expensive. Active management can’t compete with passive management, which takes us to index funds, and you can read more about them in my blog post here.
It’s one of the best things I’ve published (and 100% free), just tell me where to send it:
