Asset Allocation: The rule of 120

I get quite a few questions from friends and family of how much money should be invested in stocks versus bonds. Part of the answer lies in your own risk tolerance and preferences. I found a good rule of thumb that is based on your age and is a great starting point.

The rule of 120:

Basically you take 120 and subtract your age. If you are 25 years old the result is 95. This means that you should have 95% of your retirement assets invested in the stock market and 5% in bonds. This is not a concrete rule just some general guidance.

Using this rule is a good way to slowly make your portfolio less aggressive as you age. Once you hit at 65 you would be invested in 55% stocks and 45% bonds. This is a reasonable asset allocation for someone entering retirement. No matter your age you will have some money invested in stocks to outrun inflation.

This rule is good to use to get a basic idea of how to invest. Once you figure out your own mix you would need to invest in the correct mutual funds to cover all the bases. As long as you have a well diversified portfolio with low expenses you will be on the right track.

Retirement Account Strategy: Priority List

The average person can be easily overwhelmed with all of the different retirement account choices. The rules can be complex and some wonder where they should put their money to be sure they are getting the best deal. Taxes and investment choices have to be considered.

I have come up with a prioritized list of how to invest your retirement money. You should do number 1 first, number 2 second, and so on. I also explain why each one is important.

1. Company 401(k) or similar plan - Do this only until you have maxed out the amount the will match. If the company offers no matching contribution skip to step 2.
2. Roth IRA - If you qualify contribute until you max out this one. Currently $5000 per year or $6000 if over 50. If you earn too much to qualify then do this in a Traditional IRA which everyone can have.
   
3. Company 401(k) or similar plan - once you max out the 2 above you can contribute over and above the matching limit to save on taxes. If your company plan has poor choices for investment then I suggest skipping to the next step. The tax benefit would be outweighed by poor returns.
   
4. Taxable Brokerage Account - If you max out all of the above (which is unlikely for most of us) you should continue to invest in a taxable brokerage account.

All of the accounts mentioned here comprise your total retirement assets. If you are investing some in a taxable account I would suggest having the bonds/cash portion in this account. They have historically lower returns and therefore less tax burden for you. You should not comprimise your asset allocation, though. If you max out the bond/cash portion in the taxable account continue to invest in stocks in the taxable account. Big picture is very important here.

This is a good general guide for everyone to use. Employer match is free money that should not be left on the table. The Roth IRA is tax free withdrawals in retirement and can save you thousands later. Following the above plan will ensure that you get the most for your money in the long run no matter how you invest.

My Asset Allocation for Retirement Investing

I thought I would share how I allocate my investments for retirement. I find that this asset mix has a good risk/return ratio that I am comfortable with for the long term. Bear in mind that I am willing to take more risk than the average investor.

I have 5 main categories to choose from:

1. Domestic (USA) stocks
2. International Stocks (outside USA)
   
3. Bonds (USA Domestic)
4. Bonds (International)
5. Alternative Asset (Such as real estate, gold, etc.)

Here are my percentage allocations that I try to maintain:

1. Domestic (USA) stocks - 30%
   
2. International Stocks (outside USA) - 60%
   
3. Bonds (USA Domestic) - 5%
   
4. Bonds (International) - 5%
   
5. Alternative Asset (Such as real estate, gold, etc.) - 0%

I am heavy into international stocks as I live and work in the USA so I already have a lot of my financial life "invested" domestically. Most people already have Real Estate alternative asset by owning a home. One asset I did not mention here is cash as I believe that no retirement money should be in cash unless you are retired. I would include CD's as part of the bonds category.

For the lazy people out that I recommend using the fund of funds out there that have a target retirement date such as 2040, for example. They do a reasonably good job in asset allocation and are lower risk that I prefer. They are also low cost in fees as well as they are very easy to administrate.

One general rule I read about is that for more risk adverse investors: Your percentage asset allocation in bonds should roughly equal your age (until about age 70). I am currently more aggressive than this since I am not 10 years old. You can also simplify this rule about by staying 20% until age 30, 30% until age 40, and so on. This keeps you a little more aggressive in stocks but also reduces your weight in them over time. The choice is yours.

Overall asset allocation is key to staying on track for retirement. Review and adjustments are best done once a quarter. I do mine every Feb, May, Aug, and Nov. I chose these months as they are not at the end of the normal business quarter where things can change drastically over night and possibly throw you off more. Be smart about your investing and compound interest will take care of the rest!