A repurposing of the food pyramid in an attempt to quickly/easily convey the concept of asset allocation:
For any other bloggers: Feel free to copy/paste the image and use it on your own blogs. (A link back would be super, but it’s not entirely necessary.)
As to the specifics, there are plenty of variables that go into the decision:
- How long do you expect it will be before you need to liquidate your investments?
- How comfortable are you with volatility?
- How do you expect your level of spending during retirement to compare to your level of spending prior to retirement?
- At what age do you plan to retire? And do you plan to retire completely or continue working part-time?
As a result of the number of variables involved–and the fact that they’re not all quantifiable–there’s just no way to provide the “perfect asset allocation” for anyone.
That said, it can certainly be worthwhile to look at a couple sample asset allocation suggestions to give us a starting point for discussion.
Example 1: The rule of thumb
The most commonly-used rule of thumb for asset allocation states that an investor’s bond allocation should be equal to her age. That is, if she’s 30 years old, she should be 70% invested in stocks, and 30% in bonds.
Example 2: Target retirement funds
As you’ll learn if you stick around here for long, I’m a big fan of target retirement funds (assuming they’re low cost, passively-managed ones). Vanguard’s target retirement funds have the following “glide path:”
- 25+ years until retirement: 90% stocks, 10% bonds
- 20 years until retirement: 83% stocks, 17% bonds
- 15 years until retirement: 75% stocks, 25% bonds
- 10 years until retirement: 68% stocks, 32% bonds
- 5 years until retirement: 60% stocks, 40% bonds
- At retirement: 50% stocks, 50% bonds
- 5 years into retirement: 36% stocks, 64% bonds
- 10+ years into retirement: 30% stocks, 70% bonds
Determining your asset allocation
Again, there’s really no way to provide hard and fast rules here. The age-based rule of thumb provides a pretty decent example of a conservative asset allocation, and Vanguard’s target retirement funds are a good example of a rather aggressive allocation.
My advice? While you’re still a good distance from retirement, either of the above asset allocations (depending primarily upon your tolerance for volatility) should be fine.
Once you get closer to retirement, however, there’s a much smaller margin for error. Being weighted too heavily toward stocks exposes you to potentially devastating results if the market has a particularly bad year at the wrong time (i.e., early in your retirement). Conversely, shifting too far into fixed income exposes you to risk of running out of money due to inflation.
For an investor nearing (or in) retirement, it can be well-worth the money to pay for an appointment or two with a fee-based financial advisor.
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{ 10 comments… read them below or add one }
Great illustration! I love it.
Ah, but where would we be without our great art and collectibles.
(Seriously, good idea. Like it.)
@Miranda: Thank you.
@Monevator: Hehe, indeed. If only we’d all bought paintings and beanie babies instead of investing in the market…
Now that’s speaking my language!
So how does a 20-something relatively poor guy get started investing in diversified stock?
Hi BGP.
I’d suggest opening a Roth IRA with an online brokerage firm, then investing in ETF shares. (ETFs are essentially index funds that are bought and sold like stocks, so the minimum investment is likely to be far lower than with mutual funds.)
As far as I know, etrade’s Roth IRAs have no account fees, so that might be a good way to go. Then as far as choosing which ETF, I’d simply go for one that tracks a very broad index. (For instance, Vanguard’s “Total Stock Market” ETF might be a good choice.)
Why bond funds and not individual bonds? Individual bonds are fixed income investments that you can hold to maturity to get your money back; in the meantime you can collect fixed interest. Bond funds go up and down in value. When interest rates go up as they will eventually, ALL bonds in your bond funds will lose value. With individual bonds you’ll have an option of holding to maturity.
Hi Kitty.
There’s absolutely nothing wrong with individual bonds.
I would caution, however, that they often carry unreasonably high broker commissions.
Also, individual bonds are subject to the same price fluctuations that bond funds are. Functionally, owning a bond fund is the same as regularly buying individual bonds. The only difference is cost (fund operating expense as compared to commission on individual bonds).
Hi Mike,
I’m a new reader of your blog. I think you have an excellent site with a well-informed readership, (based on comments I’ve read.) Thanks for the free unbiased information. Here’s my question: My wife and I are among the fortunate few who have retired recently with the help of 2 solid state pensions. (The state is Wisconsin which has a fully funded system.) When figuring our allocation, in terms of stocks versus bonds, shouldn’t we count the pensions in the bond column? And if so what percentage of bonds do the pensions comprise? I realize you’ll have to give a general answer without knowing our specific situation. Still a stab at this would be greatly appreciated.
Kenboe
Hi Kenboe. Great question.
You’re correct: A pension should be counted as fixed-income in your asset allocation.
To get a ballpark figure of what portion of your overall net worth each pension comprises, I’d suggest checking to see how much a Single Premium Fixed Immediate Annuity would cost if it had the same terms as your pension. Here’s Vanguard’s quote page where you can plug in all the variables to get a figure.