Asset Allocation Calculator
Once you've decided to start investing your money, you'll have to decide on an asset allocation that's appropriate for your goals, age and risk tolerance. And unless you invest in a target date fund (TDF) that automatically adjusts that asset allocation, you'll have to rebalance your assets over the course of your investing time frame.
A financial advisor can help you manage your investment portfolio. To find a financial advisor who serves your area, try SmartAsset's free online matching tool.
Stocks
When you buy shares in a company you're investing in stocks. This is also known as owning equities. Companies issue stocks as a way of raising money and spreading risk. Some pay dividends to their shareholders. As a shareholder, you can make money through dividends, from selling the stock for more than you paid or from both. The value of shares fluctuates. The goal is generally, as you’ve likely heard, to "buy low and sell high."
You don't have to buy shares in individual companies to invest in stocks. You can also buy mutual funds, index funds or exchange-traded funds (ETFs). Individual stocks, mutual funds, index funds and ETFs all have something in common: they have the potential for relatively high returns, but also for relatively high risk.
Buying stocks comes with what's called "equity exposure," the risk that the shares you own could fall in value or become worthless. This could be due to a problem with the specific company that issued the shares or it could be caused by a general stock market crash. If you want your money to grow substantially over time, you'll need at least some equity exposure. How much you decide to allocate to stocks will depend on your goals, age and risk tolerance.
Bonds
Bonds are the foil to stocks, as they're part of the fixed-income security family of investments. They're the slow-and-steady refuge when stocks aren't performing well. When you buy stocks you become a partial owner. With bonds, by contrast, you're a lender instead of an owner. Companies and governments issue bonds to raise money. U.S. Treasury bonds are generally considered a rock-solid investment because there's virtually no risk that you'll stop receiving interest or that you could lose your principal.
Your principal? That's the amount you pay for a bond. Your bond will come with a coupon rate that represents the percentage of your principal that you'll receive as an interest payment. You keep earning interest until the bond's maturity date. If you put all your money in bonds you probably wouldn't earn enough to beat inflation by much, depending on interest rates.
Cash
Cash gives your assets some liquidity. The more liquid an investment is, the more easily and quickly you can access it and put it to use. In investment speak, "cash" doesn't necessarily mean a pile of Benjamins under the mattress. Keeping money in cash could mean putting it in a high-yield savings account or a short-term bond or CD.
Cash gives you flexibility and acts as a buffer against equity risk. But if you keep all your money in cash you probably won't beat inflation. This means your money would lose real value over time. On the other hand, if you didn't have any cash assets you could be scrambling for liquidity in the event of a big expense like a medical emergency or period of unemployment.
Your Goals
If your goal is to create an emergency fund that you might need to access at any time, the liquidity that cash offers is a major asset. On the other hand, if your goal is very early retirement (also known as financial independence), you likely need to invest heavily in stocks to get the kind of returns you'll need to grow your money by a significant amount in a short time.
We all deal with overlapping - sometimes competing - financial goals. We want to save for retirement but we also want to save for a house. We want enough money to live on in retirement but we also want a little extra money to leave to our children as an inheritance. Our priorities change over time, which is why keeping an eye on your asset allocation and rebalancing periodically is so important.
Your Age
Say you want to retire at age 67. What would you do if your investment portfolio lost 30% of its value when you hit age 65? Would you have enough money left to stick to your plan and retire at 67, or would you have to stay in the workforce for longer than you intended? Most people can't afford much volatility in the value of their portfolio so close to retirement.
That's why it's generally suggested that you allocate relatively more to bonds as you get closer to retirement. If you have an asset allocation of 90% stocks and 5% cash and 5% bonds at age 60, you'll have high potential for growth but also high risk. That's a very aggressive portfolio for someone of that age. If you have an asset allocation closer to 45% stocks, you'll end up with lower risk that your net worth might take a dip you can't afford. On the other hand, having 0% in stocks might not earn you enough over the next seven years to get you ready for retirement.
Your Risk Tolerance
We've already talked about how investing in stocks comes with the risk that your net worth could drop. Some people tolerate risk better than others. If you're very risk averse, you won't want to keep 90% of your assets in stocks. If you like the thrill of risk and you don't mind experiencing ups and downs, a high percentage allocated to stocks won't phase you.
The key to thinking about risk tolerance and investing is balancing your innate risk tolerance with the other two factors discussed above - your goals and your age. For example, if you reach age 65 and you're as risk-loving as ever, you might want to let your age and your goal of impending retirement moderate your aggressive investment strategy. If you're a conservative investor, but you're 22 and earning an entry-level salary, you might want to overcome your conservative instincts and bump up your stock allocation so that you'll save enough for retirement. You get the idea.
Bottom Line
Allocating your assets is a personal decision and it's not a decision to make once and then forget about. Say you set your portfolio to be 80% stocks, 15% bonds and 5% cash. If you reinvest the dividends from your stocks, you'll eventually end up with a higher proportion in stocks than the 80% you started out with. Not to mention the fact that you'll probably want to change your asset allocation as you age and your goals change. It's your money – it’s important to put it to work in the way that makes sense for you.
