Key Takeaways:
- The two inputs to determine suitable asset allocations are time horizon and risk tolerance. Both of these inputs are personal decisions.
- There are free, readily available resources that anyone can use to determine the starting asset allocation.
Asset allocation is the strategic decision to determine what proportion of your money to put into different asset classes (e.g., stocks, bonds). There are a couple of factors to consider – the two main ones are time horizon and risk tolerance.
- Time Horizon. This factor is the expected time frame (months, years) you have for achieving a specific financial goal. The longer the time frame, the more volatility the portfolio can support. On the other hand, a short time frame likely means an investor should take less risk if possible.
- Risk Tolerance. Each investor has a different attitude towards risks. An investor’s ability and willingness to cope with losses for a given goal drive the type of assets to allocate in the portfolio. If the investor has a lower risk tolerance, the investor should weigh assets with lower risk more heavily.
Before deciding the specific asset allocation, a critical step is breaking down your savings target by reason and financial goal. For example, you may be saving for retirement, home purchase, and children’s college. Each of these buckets has a different time horizon and, potentially, risk tolerance. This approach helps you structure your asset allocations across defined goals.
Diversification is Key
One takeaway of the Modern Portfolio Theory is that diversification is key to reducing risks and maximizing returns. A well-diversified portfolio is balanced across different asset categories and within those asset categories as well.
For example, a portfolio that is all in stocks is not as diversified as one that has both stocks and bonds. Also, a portfolio with only technology stocks is not as diversified as one that covers the broad market, including all industries.
So, how do you go about determining the asset allocation for you?
A Shortcut. Resources to Use
Luckily, there are ample online resources available to help you determine your asset allocation. Many financial institutions provide the tool to combine your time horizon, risk tolerance, and self-reported behaviors to guide you. Below are a couple of examples.
- Wealthfront
- Betterment
- TD Ameritrade Essential Portfolios
- Charles Schwab Intelligent Portfolios
Note: You may need to go through the get started process to see what these platforms suggest based on their unique questionnaires. You do not need to commit at the end of the questionnaire.
These resources lead you to an asset allocation that might look something like the below:
- U.S. Stocks – 25%
- Foreign Stocks – 20%
- Emerging Markets – 10%
- Dividend Growth – 5%
- Bonds – 30%
- Commodities, Real Estate, & Other – 10%
Not only do these resources and free tools allow you to determine the potential starting point for your investment strategy, but these tools also provide the recommended stock, bond, ETF under each asset. These tools provide precise, actionable steps.
Conclusion
There are readily available resources that you can use to determine the starting asset allocation customized for your preferences. There’s no reason to wait. The best time to invest was yesterday, and the next best time is today. Get started!
Disclaimer: The contents of this website is an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.