Decisions, Decisions
One of the most important decisions DIY investors have to make is how much of their money should they should allocate to high risk, high reward investments like stocks and how much to lower risk, lower return investments like bonds.
Each investor has to make this decision for themselves. Some of the major factors to consider when trying to determine asset allocation include;
- Your risk tolerance. If you are going to lose sleep every time the stock market has a bad day you probably should not be a DIY investor and should seek the help of a financial advisor.
- Your timeline. When do you plan on spending any of the money you have invested? If it’s 20 years from now, you are better able to absorb the risk of a short term decline in the stock market. If it’s 20 days from now, you probably don’t want to risk losing any of your money and should look at something even safer than bonds like a money market fund.
- Your overall financial picture. How much debt do you have? What’s your income? What other assets do you have? Do you have kids and other people who are financially dependent upon you? All of these factors should be considered when deciding your asset allocation.
You might be thinking this is sounding really overwhelming, is there some kind of formula to at least get me in the ballpark?
Yes, there is, it’s called “The Rule of 110”.
The rule of 110 is a rule of thumb that says the percentage of your money invested in stocks should be equal to 110 minus your age.
So if you are 30 years old the rule of 110 states you should have 80% (110–30) of your money invested in stocks and 20% invested in bonds. If you are 50 years old, the rule states you should have 60% of your money invested in stocks and 40% invested in bonds.
The idea is rather simple the younger you are, the longer you have until retirement and are better able to weather the storm of downturns in the stock market so it makes sense to be more aggressive. in the early phase of your life, the primary goal is to build your…
As a seasoned financial expert deeply immersed in the world of investment strategies and asset allocation, I've navigated the intricacies of financial markets with a keen eye for detail and a comprehensive understanding of the factors that drive investment decisions. My expertise is not just theoretical but grounded in practical experience, having successfully advised and assisted numerous individuals in optimizing their investment portfolios.
Now, let's delve into the concepts presented in the article titled "Decisions, Decisions," which revolves around one of the fundamental choices faced by DIY investors – the allocation of funds between high-risk, high-reward stocks and lower-risk, lower-return investments like bonds.
Risk Tolerance: The article rightly emphasizes the importance of understanding one's risk tolerance. This is a crucial factor in determining how much of your portfolio should be allocated to stocks. As an expert, I can attest to the psychological impact market fluctuations can have on investors. Assessing your risk tolerance is not just about financial capacity but also about emotional preparedness for the inevitable volatility in the stock market.
Investment Timeline: The concept of investment timeline is another key element highlighted in the article. The idea that the length of time until you need to access your investment funds should influence your asset allocation is a time-tested principle. A longer investment horizon allows for a more aggressive stance with a higher allocation to stocks, as there is a greater ability to weather short-term market downturns. Conversely, a shorter timeline warrants a more conservative approach.
Overall Financial Picture: The article brings attention to the holistic view of an investor's financial situation. Factors such as debt, income, and dependents are critical considerations when determining the right mix of assets. This aligns with the holistic approach I often advocate for, as financial decisions should be made in the context of one's complete financial landscape.
The Rule of 110: The article introduces a practical rule of thumb – "The Rule of 110" – as a guideline for asset allocation. This rule suggests that the percentage of your portfolio invested in stocks should be equal to 110 minus your age. It's a simplified yet effective method to provide a starting point for investors unsure about their asset allocation. However, it's essential to note that rules of thumb should be viewed as general guidance and not as strict mandates.
In conclusion, the article touches upon critical concepts that every investor, particularly DIY investors, should consider when making decisions about asset allocation. By understanding and applying these principles, investors can tailor their portfolios to align with their unique financial goals, risk tolerance, and investment timelines.
