Asset Allocation: Part 2 of 5
This is the second article in a series of five that discusses asset allocation, in easy terms. The first article focused on you - what asset allocation is and why you need to use it. This article will teach you what items to determine your ideal asset allocation.
Seven main items influence your asset allocation:
- Financial goals and objectives
- Age
- Financial time horizons
- Financial position
- Risk tolerance
- Family needs
- Years to retirement
Financial goals and objectives include both long-term and short-term goals. These can include, but are not limited to – buying a home, starting your own business, funding your children’s college education and retirement. It is essential to know your goals, so you know when and how much money you will need to meet these goals. (Try Bob's Retirement Calculator and Connect to a TRUSTED Financial Advisor in your local area.)
Your age, as well as, the age of those who rely on you for financial support, has an affect on your ideal asset allocation. Often we are called upon to support a spouse, children and more our aging parents. Medical breakthroughs have lead to a dramatic increase in life expectancies. The table below shows the current life expectancies based on your age today. If you would like to get an individual life expectancy, there is a test available at My Life Calc.
| Current Age | Life Expentency |
| 50+ | 85 Years |
| 30 to 50 | 95 Years |
| 20 to 30 | 105 Years |
| 0 - 20 | 115 Years |
Financial time horizons are the time between now and when you want to realize your goal(s). This item is crucial, because it affects how conservative or aggressive you can be with your investments. You can use what is called the “rule of 72” to determine what rate of return you need on your money to double it within a set amount of years. The rule of 72 is just a mathematical formula. An example is provided below.
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Example: 72 / Rate of Return = Years to double your money Thus, 72 / 8% = 9 years |
Because of the magic of compound interest, the younger you were when you started investing, the less overall money you will have to invest to meet your goals. How do you figure compound interest?
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Example: $1 invested at 15% a year. The formula is: dollar amount x (1 + the rate of return) = amount at end of year $1.00 x 1.15 = $1.15 $1.15 x 1.15 = $1.32 $1.32 x 1.15 = $1.52 $1.52 x 1.15 = $1.75 $1.75 x 1.15 = $2.01 => 5 years Continuing with this compound formula, your initial $1 investment would give you: $4.05 in 10 years $8.14 in 15 years $16.37 in 20 years $267 in 40 years $1084 in 50 years |
Your current financial position also influences your asset allocation needs. Current income, spending habits, debt, current investments and whether you have pension income each contribute to your current financial position. The more debt you have and more lavish your current lifestyle, the more you will have to save to maintain this lifestyle in retirement.
Risk tolerance is your tolerance to assume risk. Does the thought of losing money in your investments keep you up at night? Proper allocation, based in part on your risk tolerance, can help you to sleep like a baby. You can discover your risk capacity and risk tolerance by taking the Risk-Tolerance Quiz
Family needs also impacts your asset allocation. Whether you are caring for an aging parent, have kids in college, a special needs child (who will need care after your death), a chronic illness (such as diabetes), or disability – these situations may require you to save more, work longer and invest more aggressively.
Finally, your years until retirement affect how you allocate your assets for investment. The longer you have, the more risk you can take. Also, the longer you work, the less you should have to save. This is because you will need to pull less money from your investments to pay for everyday expenses in retirement. Also, you will have fewer years to pay for in retirement.
In our next Series 3 on Asset Allocation you will learn about the different asset categories. In the mean time check out our RETRIMENT CRASH TEST and Request a Free Consultation from a TRUSTED Financial Advisor.
Asset Allocation Series by Retire Fast LLC., (Companies and mutual funds mentioned in our blog are used as illustrations or suggestions for study and are presented for educational purposes only. They are not to be considered as endorsed or recommended for purchase by Retire Fast.) Investors should conduct their own review and analysis of any company of interest before making an investment decision. Investors should further consult their accountant, tax expert and/or financial advisor before making any investment decisions. Neither Retire Fast.. nor its content providers are responsible for any damages or losses arising from any use of this information. Copyright © 2017 Retire Fast, LLC. All rights reserved.
