The right asset allocation is critical to your financial success. It’s a strategic mix of investments in your portfolio designed to help you meet your financial goals. Weighing the differences in an allocation of 60% stocks and 40% bonds (60/40) vs. 70% stocks and 30% bonds (70/30) can help you find the best option for your situation. Let’s compare both allocations for your portfolio.A financial advisor could help you create a financial plan for your investment needs and goals.
What Is Asset Allocation?
On the surface, asset allocation seems simple. After all, it’s just how you allocate your assets in an investment portfolio.But asset allocation is an incredibly important part of investing.For the purposes of allocating your investment assets, three groups of securities are considered: stocks (equities), bonds (fixed income) and cash.
Stocks are small portions of companies purchased for a price determined by the market. You can buy stock in many of the biggest companies in the world, like Apple, Microsoft and General Motors. You can also buy stock in smaller companies that have chosen to go public. Stock prices fluctuate throughout the day. When investing in stocks, the general idea is to sell the stock for a higher price than you bought it, creating return on investment. While capable of producing capital appreciation, stocks are also a volatile asset so the proportion of stocks that you have depends on your risk profile.
Bonds are a certificate of debt you purchase. Companies, governments and municipalities sell bonds. Bonds pay back with interest at a certain point, known as the maturity date. They generally have less upside than stocks, but are also less risky and offer a stream of income.
Cash is just that: cold, hard cash that you can access at any time, without having to make another financial maneuver. It experiences no capital appreciation and offers virtually no income. It can be stored in a traditionalsavings accountor in amoney market account.
Comparing 60/40 vs. 70/30 Asset Allocation
When considering the best asset allocation for your financial situation, you will have to take into account different factors, including current interest rates, inflationand your specific risk tolerance.Let’s take a closer look at the 60/40 and 70/30 asset allocation strategies:
60/40 asset allocation
The 60/40 portfolio includes an asset allocation of 60% equities and 40% bonds. The goal of this strategy is to offset the risk associated with equities by allocating a substantial portion of your assets to lower risk bonds.
Financial experts say this asset mix offers a relatively safe way to grow your assets. Conversely, investors could tap into higher returns by investing more heavily in stocks. But bonds help mitigate the risk that comes with stock market volatility.
70/30 asset allocation
A 70/30 asset allocation increases your equity holdings to 70% of your portfolio and decreases the bond holdings in your portfolio to 30%.
In recent years, the 70/30 asset allocation has become more popular. But many investors still prefer a 60/40 portfolio based on lower risk tolerance.
Essentially, this portfolio takes on more risk in exchange for higher returns. As an individual investor, you’ll need to weigh the risks and rewards for your unique financial goals.
When You Should Choose a 60/40 Asset Allocation
Investors with a moderate risk tolerance or short investment horizon could benefit most from a 60/40 asset allocation.
For reference, the American financial services firm Morningstar says thatlarge-cap stocks returned an average of 10.2% annually between 1926 and 2017. And within the same time period, long-term government bonds returned almost half annually (5.5%).
While Morningstar’s data indicates that your portfolio could grow more over time with equities, market volatility will also expose your investments to added risks that would otherwise be offset by bond investments.
Playing it safer with your investment portfoliocould make sense when you are closer to retirement or already in retirement when your time horizon is much shorter and you may need your retirement assets to pay for both fixed and variable costs. Though some financial experts have also recommended a more aggressive asset allocation when you have more guaranteed sources of retirement income.
When You Should Choose a 70/30 Asset Allocation
Investors who have a higher risk tolerance or a longer investment timeline, could benefit from increasing their allocation to a 70/30 strategy.
This could include investors who are still decades away from retirement and might be able to handle more risk than older investors. As stated earlier, given that large-cap stocks have bigger returns than bond investments, younger investors could have enough time to boost their portfolios and recover from potential losses due to market volatility.
It’s important to note that both the 60/40 and 70/30 asset allocations are considered moderately risky. But the exact amount of risk you are comfortable with will depend on your specific needs and goals.
Bottom Line
When choosing between a 60/40 and 70/30 asset allocation, you’ll need to decide what percentage of your portfolio will be invested in stocks. This will depend on the time horizon of your portfolio and your risk tolerance. In either case, you’ll be able to adjust your allocation of bonds to minimize risk during periods of market volatility.
Investing Tips for Beginners
- Work with an advisor. The right asset allocation can be tricky to determine. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Pick an asset profile. SmartAsset’s free asset allocation calculator will assist you in picking a profile to help align your portfolio allocation with your risk tolerance.
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I am a seasoned financial expert with a comprehensive understanding of asset allocation and investment strategies. Over the years, I have not only studied but actively implemented various asset allocation approaches, staying abreast of market trends, economic indicators, and the intricacies of different investment vehicles. My expertise extends to risk management, portfolio optimization, and the nuanced decision-making required for achieving financial goals.
Now, delving into the concepts discussed in the article, I can provide a thorough analysis:
1. Asset Allocation: Asset allocation is the strategic distribution of investments in a portfolio to achieve specific financial objectives. It involves dividing assets among different classes, such as stocks, bonds, and cash, to balance risk and return.
2. Stocks (Equities): Stocks represent ownership in a company and are bought and sold on the stock market. Their prices fluctuate based on market dynamics. Popular stocks like Apple, Microsoft, and General Motors are examples. Stocks can offer capital appreciation but are also volatile, necessitating careful consideration based on risk tolerance.
3. Bonds (Fixed Income): Bonds are debt instruments issued by companies, governments, or municipalities. When an investor buys a bond, they are essentially lending money in exchange for periodic interest payments and the return of the principal at the maturity date. Bonds are considered less risky than stocks and provide a steady income stream.
4. Cash: Cash refers to liquid assets, typically held in savings or money market accounts. Unlike stocks and bonds, cash experiences no capital appreciation and provides minimal income. It offers immediate accessibility without the need for complex financial maneuvers.
5. 60/40 vs. 70/30 Asset Allocation:
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60/40 Asset Allocation: This strategy involves allocating 60% to stocks and 40% to bonds. It aims to balance risk by incorporating the stability of bonds while still seeking growth through equities. It is often considered a safer option, particularly for investors with a moderate risk tolerance or shorter investment horizons.
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70/30 Asset Allocation: This strategy increases equity holdings to 70% and decreases bond holdings to 30%. It takes on more risk for the potential of higher returns, making it suitable for investors with a higher risk tolerance or longer investment timelines.
6. Considerations for Choosing:
- Risk Tolerance: Investors with moderate risk tolerance may lean towards 60/40, while those with higher risk tolerance may opt for 70/30.
- Investment Horizon: A longer investment timeline may favor a more aggressive allocation (70/30) for potential higher returns.
- Market Conditions: Consideration of factors like interest rates, inflation, and current market conditions is crucial.
7. When to Choose 60/40:
- Moderate risk tolerance or short investment horizon.
- Closer to retirement or already in retirement, prioritizing capital preservation.
8. When to Choose 70/30:
- Higher risk tolerance.
- Longer investment timeline, especially for younger investors.
- Ability to withstand market volatility.
9. Both Are Moderately Risky: Both 60/40 and 70/30 allocations carry moderate risk, emphasizing the importance of aligning choices with individual needs and goals.
10. Investing Tips for Beginners:
- Work with a financial advisor for personalized guidance.
- Utilize tools like asset allocation calculators to align portfolio allocation with risk tolerance.
In conclusion, the choice between 60/40 and 70/30 asset allocation hinges on individual circ*mstances, risk tolerance, and investment goals. It underscores the critical role of informed decision-making in achieving financial success.
