Asset Allocation: Finding Your Number

Asset allocation means deciding what percentage of your portfolio goes into stocks vs. bonds. It is the most important investing decision you will make -- more important than which specific funds you pick.

The Traditional Rules of Thumb

"100 minus your age in stocks"
If you are 30, hold 70% stocks. If you are 60, hold 40% stocks.

This rule was developed when life expectancies were shorter. Many financial planners now suggest:

"110 or 120 minus your age"
If you are 30, hold 80-90% stocks. If you are 60, hold 50-60% stocks.

These are starting points. Your actual allocation depends on:

The Real Question: Can You Handle the Drop?

Theory says you should hold more stocks when you are young. Practice requires that you actually hold those stocks through a 40-50% crash without selling.

The 2008 financial crisis is the test case. The S&P 500 fell 57% from peak to trough. Investors who sold at the bottom and went to cash -- to 'wait for things to settle down' -- crystallized massive losses and missed the recovery.

Investors who held or kept buying ended up fine. Many ended up better than before the crash.

The right allocation is the most aggressive one you can hold through a 50% crash without changing course.

A Framework for Deciding

Ask yourself honestly:

If your $100,000 portfolio became $50,000 tomorrow, what would you do?
- Sell everything and wait: lower your stock allocation
- Hold and feel sick: you are probably at your limit
- Buy more: increase your stock allocation
When do you need this money?
- Under 5 years: heavy bonds or cash
- 5-10 years: 50-70% stocks
- 10-20 years: 70-90% stocks
- 20+ years: 80-100% stocks
Do you have other income sources?
- Pension, rental income, Social Security = more tolerance for stock volatility
- No safety net = consider more bonds for stability