Investing for the Long Term: Asset Allocation Is Critical
How you break up your money
By Mauricio Dreher
If you are a typical adult, thinking about your financial situation and retirement, you need to involve the idea of Asset Allocation. It is simply how you break up your money in terms of what percentage of your capital goes into each asset class. A basic concept for retirement is the longer you have to go before retirement, the more time you have for your capital to grow. As such, while you are young, you could allocate more capital to aggressive assets with the idea they could grow quicker and produce higher returns than assets which are considered more conservative. In addition, with a long period of time involved, aggressive assets have more time to recover in the event a specific asset class has a down period.
The main asset class when thinking about higher risk would be equities. Equities typically do have higher returns than other more conservative asset classes, especially over a longer period of time, say 10 years. But equities do not always outperform other classes, and during the period from 2008-2009, equities have had their worst return in many decades. Historically, however, equities do have better returns for a long period of time.
From an asset allocation perspective, a model for an investor is to think about one’s age and use it as a guide for asset allocation. A typical model for someone that age from 21 to 30 years old could use an asset allocation like this:
Asset Allocation – Ages 21-30
•Emerging Markets, Resources, Precious Metals, etc. = 10%
•Equities = 70%
•Bonds = 20%
Notice the low percentage of bonds in the younger person’s asset allocation model. As one gets older, usually the percentage of fixed income as an asset class will increase, and the percentage of equities should decrease. Also, other assets might be included for diversification purposes, such as Emerging Markets, Resources or Precious Metals.
For investors ages 45-60, for example, the asset allocation model could look like this:
•Equities = 40%
•Bonds = 30%
•Real Estate Funds = 20%
•Cash = 10%
Please be aware that you shouldn’t use the examples above as a general rule, since each person has its own objectives, risk tolerance, constraints, time horizon, tax situation, and unique circumstances that should be considered when trying to create an asset allocation model. These models should be created in conjunction with an investment policy statement, as written on my last article. As always, it is best to work with a CFP – Certified Financial Planner to formulate these documents to help implement and stick to a specific investment strategy pertinent to each specific individual.
As an initial idea for Asset Allocation, start by using the old saying: “Don’t put all the eggs in the same basket”.
See you next time…