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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.
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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 |
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Source: IRS Publication
590
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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:
| |
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%
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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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-- Posted: June 15, 2000
DOROTHY ROSEN has a master's degree in finance, with a specialization in accounting,
from the Kellogg Graduate School at Northwestern University in Evanston,
Ill. Rosen has more than 15 years of experience in the financial arena, serving
in Illinois and Florida as a certified public accountant, financial consultant,
expert witness and educator. She is owner of Dorothy Rosen, CPA, a public
accounting firm that serves individuals and small businesses.
