Stocks and Bonds: How To Allocate Your Portfolio’s Holdings
If you watch any financial news program or read investment-based articles, you might notice something interesting – they’re usually about stocks. There might be a bit about currencies, commodities and bonds, but by and large stocks get the most coverage.
There’s a good reason for it: stocks tend to be the first type of asset class anyone can invest in, generally through mutual funds and 401k’s. When you open up a brokerage account, you’ll likely trade stocks and not get access to more complex investments, like futures and currencies. The problem is that this unequal distribution can lead to investors neglecting other assets like bonds in favor of stocks. A portfolio made up of just one asset class – even if it’s internally diversified – can lead to big losses for those that aren’t aware of the risk they’re taking on.
Allocation and Risk Tolerance
Having a diverse set of assets in your portfolio is the key to maximizing returns without taking on undue risks. But, in order to know what kind of setup you need to have, you need to first ask yourself what kind of risk you’re willing to take on. You need to know what your risk tolerance is.
While there are a number of tools online that will help you figure out what type of investor you are, there’s a good chance you already know if you’re conservative or aggressive. A good rule of thumb for building a portfolio is to take your current age and subtract it from a number to figure out what percentage you should have in stocks and bonds.
Conservative investors should subtract their current age from 100 and use that number as the percentage of their portfolio that should be invested in stocks. For example, if you’re 30 years old and fairly conservative, you should have 70 percent of your portfolio in stocks and 30 percent in bonds.
More aggressive investors can subtract from 115. In that case, you would want 85 percent in stocks and 15 percent in bonds.
Following this simple rule can help you avoid unexpected losses without disregarding the importance of exposing your portfolio to profitable investments.
One thing to keep in mind when constructing a portfolio is what type of financial instrument you should be using. With stocks, there are a number of options, such as mutual funds, ETF’s and individual equities. But bonds are a little trickier to invest in. Typically, bonds are purchased in lots of $10,000 each per bond. So unless you have a large nest egg built up, you probably won’t get the kind of diversification you need by investing directly in bonds.
Instead, you should use mutual funds to get exposure to bonds. These investment vehicles hold portfolios made up of different types of bonds in multiple industries with a diverse range of maturity dates.
Finally, you should check your portfolio allocation at least once a year. Because stocks typically outpace bonds, over time your portfolio will become more heavily weighted in stocks, which could throw off your balance. You should make adjustments as needed so your portfolio doesn’t get off track as you approach retirement.