Common asset allocation rules of thumb
Author: Brian Lesko
Source: All Things Finance
If you have investments, then there are a few common asset allocation rules of thumb that you can follow to help you better manage your portfolio. These basic rules of thumb can help you to both grow and preserve your nest egg.
A common asset allocation rule of thumb is the rule of 110. It is a simple way to figure out what percentage of your portfolio should be kept in stocks. To determine this number, you simply take 110 minus your age. So, if you are 40, then the rule states that 70% of your portfolio should be kept in stocks. The remaining 30% should be kept in bonds and cash.
This rule of thumb can be adjusted to reflect your own personal risk tolerance. If you have a high tolerance for risk, then maybe you want 80% or even 90% of your portfolio in stocks. The opposite holds true as well.
Note that there are variations to the above rule. One of them is the rule of 100. It is the same as above, but it slides more to the conservative side of the scale. Recently, there is gaining popularity for the rule of 125. Again, it is the same as above, but using 125 will put a higher percentage of your portfolio into stocks. Which rule you choose to use will depend on your tolerance for risk and volatility.
Rebalancing your portfolio
The 5/25 rule can help you keep your portfolio allocations in line with your goals. This asset allocation rule of thumb can seem complicated, but it is straightforward to understand once you see how it works.
The "5" means that if any large block asset of your portfolio deviates by 5%, then you rebalance it. If, for example, your asset allocation calls for 20% of your portfolio to contain small cap stocks, then you rebalance when that asset class hits 25% (sell some) or 15% (buy more).
The "25" is capturing the smaller portions of your portfolio, for example, anything that represents 5-10% of your holdings. This represents a 25% change in that holding. If your portfolio calls for a 10% holding in precious metal, then you would rebalance when it gets to 12.5% (sell) or 7.5% (buy.)
If you are young, then you will often be able to rebalance by simply adjusting your allocations using new money that is coming into your account. If you are older or closer to retirement, then you may have to buy and/or sell positions within your portfolio to get to your ideal allocation.
Long term outlook
The 7-year rule is one of the simplest asset allocation rules of thumb to understand. It simply states that you should only invest money in the stock market that you don't expect to need for at least seven years. This rule will help you weather market downturns and the day-to-day news headlines that can negatively impact your investments. It will also help you to avoid having to liquidate your holdings prematurely, which may cause you to buy high and sell low.
The proceeding asset allocation rules of thumb can help you to keep your portfolio in check and keep you headed for a prosperous retirement. Keep in mind that they are just rules of thumb and are not gospel. You will still want to do a more in-depth analysis of your portfolio or seek the guidance of a professional. But using the rules as a guide will help you to at least gets things headed in the right direction.