After the downturn, most portfolios are sagging badly. So I've been working up some really quick and easy workouts to help busy and beginning investors boost the fitness of their portfolios. This workout is about one of the most important and basic tools in the investing toolbox: allocation. It’s time for a quick check-up of how your investment assets are allocated.
Asset allocation has a major influence on the performance of portfolios and retirement accounts. What do I mean by asset allocation? What I'm referring to is the percentage of your investments that are allocated into different kinds of assets: cash; bonds or bond funds; and stocks or stock funds. You might also want to consider real estate or real estate investment trusts (REITs) as a separate asset class. For this week’s five-minute workout, go to your investment portfolio or your retirement account and figure out what percentage of your investments are in these three main asset classes, leaving aside any real estate for now. Then apply a simple formula that will help you decide if you have the correct allocation for your age. This is not a cut and dried formula, but a general guideline that will give you an idea if you’re at least in the right ballpark.
The younger you are, the greater risk you can absorb over a long investing horizon, and therefore the more you should have invested in stocks and stock funds or exchange-traded funds. If you’re twenty years old, you should only have about 20% of your retirement-fund investments in bonds and cash. Use dollar-cost averaging to minimize your risk, and by that I mean invest small amounts regularly, rather than putting all your money in stocks at once. That way, you're spreading out the risk, and you won't be at risk of putting all your money in at the height of the market. If you’re thirty to forty, that percentage of bonds should increase to thirty percent or so. At forty, you’ll be increasing your exposure to bonds to up to forty percent. At fifty, you should be edging closer to fifty percent. And so on. That’s the most conservative allocation. The higher your percentage in bonds, the higher your margin of safety, but the higher your percentage in stocks, the higher your potential return over the long term.
If you find that you’re facing more risk than you realized, it’s time to think about moving some of your investment funds into bonds rather than stocks. As you near retirement, you’re not going to want to be facing sharp swings in your portfolio’s value. But if you’re playing it too safe to build a good retirement, you might want to think about increasing your stock allocation.
