How much percentage of stocks should your assets consist?
Disclaimer: I am not a professional financial advisor. This blog and all the content in this blog are only for personal financial literacy/education. Please contact a professional advisor before taking any big monetary decision or investment.
Before we dive into the percentage of a safe mix of stocks in your investments, let us first see what are different elements through which you can diversify your portfolio and what is meant by “Asset allocation”?
An asset allocation should consist a healthy mix of Stocks, Bonds and cash.
Stocks : Stocks are small shares of ownership that you can buy from a company. It means that you get a vote in the decisions of the stockholders & Owners, you get your share of dividends when the company makes a profit and you will also share the loss equally. Meaning the risk factor is high. So with age and your risk appetite, your stock percentage should change. They give you a higher growth in long-term. Markets always fluctuate but over long-term they give better returns.
Bonds : Bonds are interest-yielding loans that you can provide either to the Govt or to a company. They are considered low-risk investments and also give low long-term growth.
Cash: Cash is the amount of cash you can hold in high interest-yielding accounts(like CDs/RDs/FDs) or Money-market funds. There are certain banks that are virtual that provide better interests than typical banks like Bank of America, Chase, etc. These banks(Ally, CIT, etc) are virtual but FDIC insured give high interests as they don’t have physical structures to maintain. You can also invest in money-market funds. But both of these are very low growth yielding assets. They simply provide security to your money but do not provide much growth.
Now, coming back to the question of % of stocks in your asset mix. There has been lot of research on this. There is no way to answer this with on-size-fits-all solution. We can only make best out of what we have(balance risk and growth factors).
With that said, experts believe that the percentage of stocks should always be 100 minus(-) your current age.
So, if your age = 30 years
stocks = 70%(100 – 30) of your Asset allocation.
Similarly if your age is 70, then your stock percentage should be 30%.
Since Stocks can be volatile and risky, you should reduce the percentage of them in your assets as you age. Bonds, Cash and some amount of gold can also be a part your assets which are more secure and you can easily liquidate them in your old age. It is also advised by experts that you may have to subtract your age from 110 or 120(instead of 100) because you may outlive your savings.
Alternative combinations of Stocks
Though we have a general formula, there are many experts/super-investors like Warren Buffet who believe otherwise. It is also indicated that after he passes, he ordered the trustee of his wife to invest 90% of the money she receives into a low-risk index fund(mix of several stocks) and 10% in short-term treasuries even at that age. Crazily, in the experiment conducted by the Spanish professor I mentioned above, it has given better results than what everybody thought though it was a risky combination(. These are exceptions though, we cannot risk like Warren Buffet or his wife.
But the safest percentage is 60-40(60% stocks and 40% Bonds and other low-risk investments) as per a Spanish finance professor, Javier Estrada who conducted an experiment and published a paper. This was better risk-balanced to last more than 30 years after your typical retirement age(60 or 65) even after 4% withdrawal every year with inflation included.
So in conclusion when you are buying stocks, along with age also consider your risk appetite. You can also consider buying ETFs or index funds instead of stocks directly which diversify into different sectors or all the companies in S&P. Stay tuned for more articles on ETFs and index funds.
- Investopedia article on Is Warren Buffett’s 90/10 Asset Allocation Sound?
- CNN Money article on “Best asset allocation for my age“