When To Change Asset Allocation
Your asset allocation doesnt have to be set in stone forever. It can change based on life events or new information.
Life events could be things like having children or getting married or divorced. These things change your future needs, and your asset allocation should be updated to match those revised financial liabilities.
What I mean by new information is things like:
- Having more money than you need for retirement.
- Being close to the amount of money you need for retirement.
- Realizing you initially overestimated your risk tolerance. This one is very likely to happen.
If you end up with more money than you need to cover your expenses and lifestyle in retirement, thats a great problem to have. This might mean you choose to leave some portion to heirs. In this case, the asset allocation for that portion should likely be more aggressive than yours, as the younger heirs may have a longer time horizon. Suppose you realize you only need half of your retirement savings and you want to bequeath the other half. Also suppose your conservative asset allocation in retirement is 20/80 but you determine an appropriate allocation for the half to be left is 80/20. This results in an overall asset allocation of 50/50 for the total amount.
Put Aside Money For A Rainy Day
Having money available for unexpected expenses, regardless of your financial position, is extremely important. In fact, allocating some portion of your excess savings to an emergency fund takes priority over extra debt repayments or additional investing.
In general, an emergency fund should contain three to 12 months of expenses. If your emergency fund is starting from zero, then allocate at least 10% of your excess savings each month to this account. If you have a high degree of job security and income predictability, then you can probably build this account up more slowly.
Consider keeping your emergency fund in an online account to earn a higher interest rate than you would in your primary checking account. As an added bonus, keeping your emergency savings separate from your primary checking reduces the temptation to access those funds for non-emergency purposes.
Asset Allocation And Risk Tolerance
Investor behavior plays a big part in asset allocation in the form of risk tolerance. A successful asset allocation strategy requires that the investor is able to stick to it. Modern Portfolio Theory assumes all investors behave rationally and unemotionally. We know this isnt the case.
The investor is usually the cause of the failure of their investment plan, not the financial markets. As you might imagine, plans are typically abandoned during crashes or extreme bull markets. One of the mistakes most often made is the overestimation of ones tolerance for risk. Risk tolerance can be defined as the point at which price volatility or drawdown causes you to change your behavior. Obviously, for a young investor with no experience, this point can be hard to assess.
Stocks are more risky than bonds. Buying stocks is a bet on the future earnings of companies. Bonds are a contractual obligation for a set payment to the bond holder. Because future corporate earnings and what the company does with those earnings are outside the control of the investor, stocks inherently possess greater risk and thus greater potential reward than bonds.
William Bernstein suggested that an investor can evaluate their risk tolerance based on how they reacted to the Global Financial Crisis of 2008:
- Sold: low risk tolerance
- Held steady: moderate risk tolerance
- Bought more: high risk tolerance
- Bought more and hoped for further declines: very high risk tolerance
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What Is The Best Way To Invest Money
1. Invest for a minimum five years
To get a decent return, you should invest for at least five to ten years. The longer you invest your money, the more time you have to:
- Accrue returns on your investment portfolio
- Ride out any market downturns
- Let your returns compound
2. Choose a low cost platform
Fees can erode your pot over time, so we have outlined some of the best platforms for both cost and customer service here.
According to investment platform Vanguard, if you invested £10,000 for 30 years, assuming investment growth of 5% a year, your pot would be:
- 2% fee = £24,270
- 0.5% fee = £37,450
Watch out for early exit charges to access money within a few years of investing as well, as these can run into hundreds of pounds.
3. Choose a tax-efficient wrapper
You should use a tax-free wrapper to protect your investment returns from the taxman.
There are different types of tax-free financial products for you to consider, such as:
- Pensions: find the best ready-made pension providers here
- Stocks and shares ISA: we outline the best ones, including the best robo-adviser account, which chooses a portfolio for you
- Lifetime ISA : heres our list of top providers
Within these products, you would then choose what to invest in. Here are tips on how to choose investment funds.
Why Mutual Funds Are Best For Young Investors
A mutual fund is an investment that contains a basket of securities. Investors buy into the fund by pooling their money. The fund could contain stocks, bonds, or a mixture of investments and it’s usually managed by an investment manager. The fund might track an underlying index, such as the S& P 500, or it could be designed to invest in a select number of stocks or securities, such as technology or bank stocks.
Mutual funds are not just for beginners or young people. They are used by professional money managers and expert investors around the world. Below are the primary reasons mutual funds can be an ideal investment for those in their 20s or beginning investors:
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Do You Need A Financial Advisor
So, if you’re thinking of getting started investing, do you need a financial advisor? Honestly, for most people, they don’t. But a lot of people get hung up on this need for “professional” advice.
Here are some thoughts on this subject from a few financial experts :
I don’t believe that young investors need a financial advisor. Rather, what this age group really needs is financial education. Relatively speaking, their financial situations aren’t “complex” enough yet to warrant the cost of an advisor or planner.
Being proactive and increasing their financial literacy now will make those future conversations more productive by “speaking the same language” as an advisor, they’ll be better equipped to state their specific goals and discuss potential courses of action. Relying on an advisor today instead of properly educating themselves, however, could lead to costly dependency issues in the future.
Learn more about Tara at Reis Up.
The straight financial science answer is you should only pay for advice that puts more money in your pocket than it costs you.
Learn more about Todd at Financial Mentor.
The fact is simple: most people getting started investing after college simply do not need a financial advisor. I think this quote sums it up best for young investors:
Learn more about Nick at Mapped Out Money.
Simply put, if you are struggling to come up with your own financial plan , it could make sense to sit down and pay someone to help you.
Candidates For The Financial Samurai Asset Allocation:
- Have multiple income streams.
- Are a personal finance enthusiast who gets a kick out of reading finance literature and managing your money.
- Not dependent on your 401k or IRA portfoliso in retirement, but would like it to be there as a nice bonus.
- Enjoys studying macroeconomic policy to understand how it may affect your finances.
- Is an early retiree who wont be contributing as much to their portfolios as before.
- Also invests in real estate to diversify and smooth out the volatility of stocks. Real estate is actually my favorite asset class to build wealth because it is easy to understand, is tangible, provides utility, and has a solid income stream.
- Given a Financial Samurai is a real estate investor, real estate acts as a Bonds Plus type of investment. In other words, real estate is defensive during a downturn as more capital goes towards real assets. Real estate also tends to do well as more investors buy bonds, resulting in lower interest rates. At the same time, real estate tends to do well during strong economic growth due to rising rents and rising real estate prices.
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What Should Your Portfolio Look Like In Your 30s 40s And 50s
How you invest can depend a lot on your age, and your portfolio could look significantly different depending on where you are in life.
Start investing as soon as you can to take advantage of the power of compounding. The younger you are when you begin investing, the more time you have for your initial investments to grow and increase your personal wealth. There are investments you can make during each decade of your adult life to take advantage of the power of time.
Saving for retirementespecially starting at an early ageis a good idea and almost always beneficial. However, investing does come with risks that are important to understand.
Historical Return For Bonds
The proper asset allocation must take into consideration bond returns. The average return for long-term U.S. government bonds is between 5% 6%.
Bonds and interest rate performance is inversely correlated. Since July 1, 1981, the 10-year bond yield has essentially been going down thanks to technology, information efficiency, and globalization. As a result, the 10-year bond has performed well during this same time period.
Below is a chart that compares the Vanguard Total Stock Market fund versus the Vanguard Long-Term Investment Grade Bond fund. As you can see, VWESX has actually outperformed VTSMX over a 20-year period. Therefore, dont look down on bonds, despite low rates.
Below is another chart that shows asset class real returns by decade.
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Financial Mistakes You Will Regret At Age 50
Delay investing till income is higherTaking too little risk with investmentsPrakriti Ojha, 31 years, MumbaiIncome: Rs 1.1 lakh a monthEquity exposure: Nil She is young, earns well and has a steady job. Yet she invests primarily in PPF and bank deposits, something she may regret later in life.Not following an asset allocationGetting lured by dubious schemesAnkur Sachdeva, 36 years, DelLost: Rs 11.6 lakh in Stock Guru scam in 2012 He was initially skeptical and invested Rs 2 lakh in the Stock Guru scheme. When he got back Rs 40,000 in a month, he put in Rs 10 lakh more but got nothing back.Investing in stocks for short termDipping into PF accountRadhika Sachdeva, 35 years, GurgaonJob changes: Four in the past 12 years PF Balance: Rs 15 lakh Despite changing four jobs in the past 12 years, she has never withdrawn her PF. This will help her in retirement.Treating insurance as investmentAmit Acharya, 45 years, RaipurPremium paid: Rs 1.5 lakh per annumReturns expected: 6% He invested in life insurance policies on the advice of his father. The high premium of these plans prevent investing in other lucrative avenues.Splurging on items you dont needTaking too little life and medical insuranceHemant Kumar, 39 years, NoidaIncome: Rs 22 lakh per annumLoans: Rs 25 lakh Insurance cover:INSURANCE COVER: Rs 6 lakh The sole earner in the family, Kumar needs an insurance cover of at least Rs 1-2 crore. That wont come cheap when he crosses 40.Not setting up an emergency fund
Knowing The Basics Of Investing
Investing can seem intimidating at first. Theres a lot to learn.
Start with the basics. Set aside time to learn about 401s, stocks, mutual funds and asset allocation. Understand the relationship between risk and reward.
Once youre familiar with these concepts, pick the best way to invest your money. Thanks to technology, theres more choices than ever before.
Ways to Invest Your Money
- An employer-sponsored 401 plan
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What Is Your Investing Goal
How you invest depends on what exactly youre investing for. You might be investing money for a down payment on a house you intend to buy in 6 months. Maybe youre investing to help your 14-year-old with her sooner-than-you-think university tuition. You might want to invest money to live off of when you retire in 30 years or so. Notice the biggest difference among these three goals? The time horizons. Your investing decisions will be considerably different based on when youll need your money.
Also: if you dont have an emergency fund set up or still owe high-interest debt, such as credit card debt, then you should focus on that before you start investing. An emergency fund should cover at least 3 to 6 months of living expenses if the unthinkable should happen and should be stored somewhere where it isnt touched.
The Best Investments For Your 30s
If you’re in your 30s, you have 30 years or more to profit from the investment markets before you are likely to retire. Temporary declines in stock prices won’t hurt you as much because you have years to recoup any losses. So if your stomach can handle the volatility of stock prices, now’s the time to invest aggressively.
Expert Tips For Young Investors
Christopher Magnussen is a financial services expert with more than 20 years of investment experience at TD Ameritrade and other institutions. He is currently a financial advisor with Insuractive.
Ive seen some young investors who make trades on online brokerage accounts like people make bets at a casino. You need to understand the consequences of your investment decisions.
Dont just buy five shares of trendy stock because your friend says its a great idea.
If youre allocated across several asset classes and sectors based on your risk profile, you dont have to know whos going to win. You own some portion of every winning hand.
Even young investors need fixed income securities, such as bonds, in their portfolio. Bond ETFs, like index ETFs, are an easy and affordable way to invest in multiple assets with a single purchase. Another option is bond mutual funds.
The beautiful thing about that is it automatically takes your money out of your paycheck before you see it. Out of sight, out of mind.
Best Fund Types For Investors In Their 20s And 30s
If young investors are saving for a long-term goal, such as retirement, there is likely a time horizon of up to 30 years or more. All investors should be aware of their own investment objectives and risk tolerance. But the longer you have until you need your money, the more aggressively you can invest.
Here are the basic types of funds that young investors are wise to consider:
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What Is Asset Allocation
Asset allocation simply refers to the specific mix or distribution of different asset types in ones investment portfolio based on personal goals, risk tolerance, and time horizon. Goals refer to things you want to do or buy, such as a downpayment on a house and/or retiring at age 55. Risk tolerance refers to how much risk you can handle without deviating from your strategy well talk about this more in a second. Time horizon just means the time period for which you will hold the investment to meet your goal. For example, this could be 10 years for that house downpayment and 30 years for retirement.
Most people Ive talked to dont know the term asset allocation until after learning it. Words used by the uninitiated to refer to this same idea include mix, distribution, and split. In this context, these all refer to the same thing. Were simply talking about a ratio of different asset classes, e.g. 60/40 stocks/bonds. The three main asset classes are stocks/equities, fixed income, and cash or cash equivalents. Outside of those, in the context of portfolio diversification, people usually consider gold/metals and REITs to be their own classes too. Dont worry if all this sounds confusing right now.
Lets look at why asset allocation is important.
Is 10000 A Good Investment Amount
Yes, £10,000 is a good amount to invest. But as we mentioned, the longer you can leave your money invested, the better.
This will give it enough chance to grow and ride out any fluctuations in the stock market.
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Invest Using Robo Advisors
We’ve already discussed investing in stocks through S& P 500 index funds or commercial real estate through REITs. But if you’re not familiar or comfortable with investing on your own, you can always do so through a robo advisor.
That’s an online, automated investment platform that does all the investing for you. It includes creating your portfolio, then managing it from now on. They even reinvest dividends, periodically rebalance your portfolio and offer various tax strategies to minimize your taxable investment gains.
What’s more, you can use a robo advisor for either a taxable investment account or a retirement account, particularly IRAs. It’s hands-off investing at its best. All you need to do is fund your account and the robo advisor handles all the details for you. And they typically invest in a mix of stocks and bonds. Many also offer funds that focus on ESG stocks.
Here at Investor Junkie, we like Wealthfrontand Betterment, which are the two largest independent robo advisors. Both offer an incredible range of investment benefits and are on the cutting edge of the industry.
We made a comprehensive comparison between Betterment and Wealthfront right here.