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There isn’t one. Wasn’t that easy?
In the same manner, there isn’t one diet that fits everyone. Depending on your body fat makeup and what you’re trying to accomplish (increasing endurance, building muscle, losing weight), the proportions of protein, fat and carbohydrates you should consume can vary widely.
SEE: Introduction To Investment Diversification
Balancing Act
Thus it goes for balancing your portfolio. A former client of mine once stated that her overriding investment objective was to “maximize my return, while minimizing my risk.” The holy grail of investing. She could have said “I want to make good investments” and it would have been just as helpful. As long as humans continue to vary in age, income, net worth, desire to build wealth, propensity to spend, aversion to risk, number of children, hometown with its concomitant cost of living and a million other variables, there’ll never be a blanket optimal portfolio balance for everyone.
That being said, there are trends and generalities germane to people in particular life situations which can align risk tolerances. Seniors who invest like 20-somethings ought to, and parents who invest like singles should, are everywhere, and they’re cheating themselves out of untold returns every year.
Fortune Favors the Bold
If you recently graduated college – and able to do so without incurring significant debt – congratulations. The prudence that got you this far should propel you even further. (If you did incur debt, then depending on the interest rate you’re being charged, your priority should be to pay it off as quickly as possible, regardless of any short-term pain.) But if you’re ever going to invest aggressively, this is the time to do it. Yes, inclusive index funds are the ultimate safe stock investment, and attractive to someone who fears losing everything. The S&P 500‘s returns over the last 10 years are a testament to its “safety” and show the value that can be accumulated over time. Learning about dollar cost averaging and beginning the habit of automated investing is also important for new graduates. Still, why not incorporate a little more unpredictability into your investments, in the hopes of building your portfolio faster?
So you put it all in OfficeMax stock last January and lost three-quarters of it by the end of the year. So what? How much were you planning on amassing at this age anyway, and what better time to dust yourself off and start again than now? It’s hard to overemphasize how important it is to have time on your side. As a general rule of life, you’re going to make mistakes, and serendipity is going to smile on you once in a while. Better to get the mistakes out of the way early if need be, and give yourself a potential cushion. “Fortune favors the bold” isn’t just an empty saying, it’s got legitimate meaning.
Risk Tolerance Decreases
For most investors their tolerance for risk decreases as they enter their 30s and 40s. These investors are less willing to bet substantial portions of their worth on single investments. Rather, they are looking to build out a liquid fund for emergencies and luxury purchases while also continuing to make automated investments for the long term. Seasoned investors may also be more interested in many of the market’s targeted customized investments like target date retirement funds and target risk funds. These investors may also seek to take bets on value versus growth with the former offering income while the latter rounding out some of their higher risk allocations.
Fortune Doesn’t Favor the Reckless
Fortune doesn’t favor the reckless, however, and at some point in your life you will want to seriously begin saving for retirement. In the case of retirement it can be best to start with the three traditional classes of securities – in decreasing order of risk (and of potential return), that’s stocks, bonds and cash. (If you’re thinking about investing in esoteric investments like credit default swaps and rainbow options, you’re welcome to sit in on the advanced class.) The traditional rule of thumb, and it’s an overly simple and outdated one, is that your age in years should equal the percentage of your portfolio invested in bonds and cash combined.
It’s unlikely that there is someone on the planet who celebrates his birthday every year by going to his investment advisor and saying, “Please move 1% of my portfolio from stocks to bonds and cash.” Besides, life expectancy has increased since that axiom first got popular, and now the received wisdom is to add 15 to your age before allocating the appropriate portion of your portfolio to stocks and bonds.
That the rule has changed over the years should give you an idea of its value. The logic goes that the more life you have ahead of you, the more of your money should be held in stocks (with their greater potential for growth than bonds and cash have.) What this neglects to mention is that the more wealth you have, irrespective of age, the more conservative you can afford to be. The inevitable corollary might be less obvious, and more dissonant to cautious ears, but it goes like this: the less wealth you have, the more aggressive you need to be.
The Bottom Line
Investing isn’t a hard science like chemistry, where the same experiment under the same conditions leads to the same result every time. However, there are some basic axioms, mainly centered around age with risk, for which investors can rely on. Understanding and creating a portfolio allocation using stocks, bonds and cash that aligns with your risk tolerances and short term versus long term needs is important to begin with. From there, you can potentially broaden your investments to other alternatives like real estate or take some concentrated high-risk investments in high growth stocks to reach for some higher returns. Overall, the best portfolio balance, will be one that fits your risk tolerance, goals and evolving investment interests over time.
