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-- Posted: June 15, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

What is asset allocation?

Dear Dollar Diva,
What is asset allocation?


Asset allocation is the act of dividing your investment dollars into different categories, such as cash, bonds, stocks, and real estate, to get the maximum return for the risk you take. Risk is generally a function of time; the younger you are, the more risk you should take.

IRS Life Expectancy Table
Current Age Number of years you're expected to live
40 43.6
50 34.2
60 25.2
70 17.0
80 10.5
90 5.5
Source: IRS Publication 590

What to expect from your assets

Each investment category has a function:

Investment
Example
Purpose
Cash Money market funds, short term treasuries, certificates of deposit Safety, liquidity
Bond Long-term, intermediate-term, short-term Income
I-Bonds Income and inflation hedge
Long-term Income and deflation hedge
Stock funds Small-cap, mid-cap, large-cap, growth and income, value, international, emerging markets, index Growth historically provides highest total returns
Real Estate Home, rental property, REITs Inflation hedge

How much do you allocate to each category?

It depends on your time line and goals. Let's assume you have enough cash on hand, and want to structure a portfolio of securities for retirement. Here's what asset allocations might look like at different age levels:

Investment allocation by age
 
20-39
40-59
60-69
70-79
80+
Bonds
0%
20%
40%
70%
80%
Growth & income funds
55%
45%
35%
20%
10%
Mid-cap funds
15%
15%
10%
0%
0%
Small-cap funds
15%
10%
5%
5%
5%
International funds
15%
10%
10%
5%
5%

As a general rule, a long-term portfolio is one that will not be touched for at least 10 years; medium-term, 5 years; short-term, less than 5 years.

The best way to acquire and accumulate wealth is to develop a strategy, and stick with it. Review your holdings every year, and make adjustments to keep the percentages where you want them to be. For most people, allocating assets properly will contribute more to your portfolio than trying to pick the perfect fund.

For after-tax investments, don't adjust the percentages by selling anything; capital gains taxes eat up investment dollars. Adjust by putting more future dollars in the funds that came in under their percentages, and less in the funds that came in over their percentages.

Updated: Sept. 17, 2003

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