What Stock/Bond Allocation Is Right For You?

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Designing a portfolio usually involves a mixture of stocks and bonds. While other asset classes can be added to the mix, a typical investment portfolio is broken up by these two main asset types. Stocks offer greater returns but carry a higher degree of risk while bonds have a lower risk profile but come with lower returns. Getting the right mix is where many investors run into trouble.

Having a portfolio that’s too heavily weighted in stocks can result is greater-than-expected losses and volatility which can quickly derail a retirement plan. On the other hand, loading up on too many bonds means that your portfolio will likely under-perform expectations leading to a lower retirement balance than planned. That can mean having to work for more years to compensate or reducing your retirement plans.

In order to figure out the right balance, you’ll need to figure out what your goals are, when they need to be realized, and how much risk you can handle.

Figuring out your risk tolerance baseline

Life is not static – it’s a dynamic progression that changes and grows as you approach retirement. Plans change, sometimes for the better and sometimes for the worse. As such, you need an investment plan that allows for adjustments but still helps you reach a long-term goal.

One classic rule of thumb to figure out what stock/bond allocation is right for you is to subtract your current age from 100. Whatever the result is should tell you what allocation to use. For example, if you’re 40 years old, you should have a portfolio with a 60% stock and 40% bond mixture. But that’s for more conservative investors. Those with a higher risk tolerance should subtract from 115. That would give the same investor an allocation of 75% stocks and 25% bonds.

Subtracting from 100 or 115 will help you design a portfolio based on your age, but it’s not a catch-all for risk tolerance. There are numerous free risk assessments online like this one that can help you determine what your actual tolerance really is. There’s nothing that says you can’t adjust your allocation to be even more or less aggressive than the age-based model.

Finally, you can do a quick calculation to figure out what allocation you need by estimating the expected returns from stocks and bonds and what return you need to have. For example, let’s say you need to achieve an 8% return to reach your investment goals. If your stock portfolio should give you a 12% return and your bond portfolio will give you a 5% return, then some quick math tells you the right allocation is 43% stocks and 57% bonds.

Final considerations

While getting the right allocation helps you reduce risk while meeting your long-term investment goals, there’s nothing wrong with changing the formula. You may find yourself more or less risk-averse later on meaning that the plan needs to change to compensate. The rule of thumb based on your current age is constantly being readjusted and many advisors now recommend being more aggressive as you approach retirement than they used to. Don’t be afraid to switch gears as needed in order to reach your investment goals.