Rules of Thumb for Asset Allocation

You can choose to adopt these strategies as is or use them as a guide to drawing up a custom one. While there are others, the following two rules of thumb are the most widely used

By this time, you already know that there is more to investing than just placing your funds in an investment vehicle and waiting for returns. While there are a diverse range of strategies to help you effectively optimize gains and minimize losses, there is nothing better that having the right asset allocation ab initio.

There are a number of asset allocation strategies that prove to be effective, and while we’ll discuss some of them now, it’s worthy to note that the strategy you adopt for allotting assets ultimately depends on your risk tolerance, age, and your current financial situation.

You can choose to adopt these strategies as is or use them as a guide to drawing up a custom one. While there are others, the following two rules of thumb are the most widely used.

The 110 Rule

In balancing risk and reward, two main securities that are compared are stocks and bonds. Investors have to determine how much they want to allocate to high risk (and high return) investments such as stocks as well as how much to allocate to lower risk (and lower return) investments like bonds.

To effectively make this allocation, a key strategy used by many is what is known as the 110 rule. This rule takes into account the investor’s risk tolerance, his or her age and investment timeline, investment goals, as well as his or her financial position. Here’s how the rule works:

Subtract your age from 110. Whatever you get is what you should invest in stocks. This is because the stock market is volatile and best serves passive investors in the long run.

The younger you are, the larger the percent you should invest in stocks because you have more time for the stocks to accumulate wealth. For example, if you are 30 years old, you’d invest 80 percent of your funds in stocks and 20 percent in bonds or other safe assets.

The “age in bonds” Rule

This rule says to invest your age in bonds. If you’re 40 years old, you’d invest 40 percent in bonds. The rule aims to reduce risk the closer you get to retirement.

Younger investors are usually willing or can afford to take on more risk, hence, they can invest more in stocks that accumulate wealth over a long time.

However, investors closer to their retirement age do not have as much tolerance for risk; it is more advisable to invest in bonds that provide regular monthly or yearly payments.

Regardless of the asset allocation strategy you opt for, remember that every good strategic asset allocation strategy requires a level of rebalancing every once in a while. This is how to stay focused and make the most out of your investment strategy.

Written by Lawretta Egba.