Choosing the right asset allocation is important for managing portfolio risk and achieving investment objectives. One of the easiest strategies for setting asset allocation is to use a percentage allocation, such as 70/30 or 80/20. In either case, you invest the majority of your money in stocks, with the rest going into safer investments, such as cash and bonds. At first glance, they seem similar, but choosing a 70/30 versus 80/20 asset allocation can impact your investment goals and results.
A Financial Advisor can help you create a financial plan for your investment needs and goals.
70/30 Portfolio Basics
A 70/30 portfolio allocates 70% of your investment dollars to stocks and 30% to fixed income securities. So an investor using this strategy can invest 70% of their money in individual stocks, actively or passively managed stock-focused mutual funds, and stock-focused index or exchange-traded funds (ETFs). The remaining 30% of their portfolio would be allocated to bonds, cash and near cash.
The 70/30 portfolio is sometimes considered a substitute for the 60/40 asset allocation model. With a 60/40 portfolio, 60% of assets are allocated to stocks while 40% are allocated to bonds. A 70/30 portfolio generally carries more risk than a 60/40 split because there is a greater allocation to equities.
However, always have a decent amount of bonds and other fixed income investments to balance out market volatility. Choosing a 70/30 portfolio can also be a good idea if you’re concerned that a 60/40 asset allocation might be too conservative for your needs and goals.
Don’t miss news that could impact your finances. Receive news and tips to make smarter financial decisions with SmartAsset’s bi-weekly email. It’s 100% free and you can unsubscribe at any time. register today.
80/20 Portfolio Basics
An 80/20 portfolio works the same way as a 70/30 portfolio, except you allocate 80% of assets to stocks and 20% to fixed income securities. Again, the equity portion of an 80/20 portfolio could be held in individual stocks or a combination of stock mutual funds and ETFs.
With an 80/20 portfolio, the risk factor increases since you invest more money in stocks. The flip side, however, is that you may have more room for higher yields. Although bonds can provide consistent income, returns are generally not at the same level as stocks.
Comparison of 70/30 and 80/20 asset allocation
The main difference between the 70/30 and 80/20 asset allocation models is how much risk are you taking. With an 80/20 split, you spend more of your money in stocks, which can mean more exposure to stock market volatility. Whether it makes sense to choose a 70/30 asset allocation over an 80/20 portfolio can largely depend on three things:
How much growth do you need and want to achieve in your portfolio
Your personal risk tolerance
Your investment calendar
One of the most important things to understand when choosing an asset allocation is how much money you invest needs to grow. If you want retire at 65 with $2 million saved and you start at age 40, for example, your portfolio will have to work a lot harder than someone who starts saving at age 25.
There is also a correlation between your risk tolerance and risk capacity. Risk tolerance is the amount of risk you are comfortable taking with your investments. In theory, the younger you are and the longer you need to invest, the more risk you can afford. This is because you have more time to recover from market downturns, assuming you don’t plan to retire early.
Risk capacity is the amount of risk you need to take to achieve your investment goals. This is perhaps even more important than risk tolerance in determining whether to choose a 70/30 versus 80/20 asset allocation or a completely different percentage combination.
When you choose an asset allocation that matches your risk tolerance, but not your risk capacity, you could potentially hamper your investment goals. If you don’t invest aggressively enough, for example, you may not see the returns you’re hoping for. It could mean having less money to live on in retirement.
On the other hand, investing beyond your risk profile could expose you to greater losses. If you take more risk than necessary, you could lose money and again, the end result could be less savings for retirement.
How to choose the right asset allocation by age
Taking into consideration how to allocate assets by age, whether you’re weighing a 70/30 versus 80/20 asset allocation or something else, it’s worth looking at historical returns and your personal investment timeline. The stock market moves in cycles and there are inevitably times when stocks perform better than others.
Looking at historical returns can give you an idea of how a specific asset allocation strategy has worked over time. Past performance is not a guarantee of future results, but it can give you an idea of the level of return you are likely to see in your portfolio over time.
As retirement approaches, it is natural to opt for more conservative investments. If you are using the 70/30 or 80/20 model, for example, these could tip over in retirement. So you could invest 30% or 20% in stocks in your 60s and beyond while allocating the remaining 70% or 80% to fixed income securities.
You can also use another age-based rule to determine your ideal asset allocation. The Rule of 120, for example, suggests subtracting your current age from 120 to determine how much of your portfolio to allocate to stocks versus bonds. So if you’re 30 years old, for example, you subtract that from 110 to get 90. That’s how much of your portfolio you’ll be spending on stocks.
The rule of 120 assumes you will have a longer life expectancy, which means your money will have to last longer in retirement. As with the other rules, however, it is important to tailor it to both your risk tolerance and your risk capacity. If keeping 90% of your portfolio in stocks seems too risky, you can use 110 as a base number for the calculations.
Talking to your financial advisor can help you decide which asset allocation model makes the most sense. Your advisor can also help you develop a strategy for moving this allowance over time as you go through different life stages and get closer to retirement.
Whether you choose a 70/30 or 80/20 asset allocation, it’s important to know what you own and how much you’re paying for it. If you own multiple mutual funds, for example, find out if those funds hold the same actions. A large overlap could actually reduce diversification rather than increase it and potentially expose you to more risk. And paying high expense ratios could hurt your overall returns.
Investment tips for beginners
A Financial Advisor can help you determine the right asset allocation based on your financial needs and goals. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your advisors at no cost to decide which one is best for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
Although the 4% rule is the traditional benchmark for determining retirement withdrawals, this rule may not meet your needs. depending on the type of lifestyle you hope to enjoy. The SmartAsset Retirement Calculator can help you plan your investment and savings strategy.
If you need help choosing an asset profile, SmartAsset’s Free Asset Allocation Calculator will help you choose a profile to help you align your portfolio allocation with your risk tolerance.
Photo credit: ©iStock.com/Adene Sanchez, ©iStock.com/fizkes, ©iStock.com/fizkes
The post office 70/30 versus 80/20 asset allocation: which is better? appeared first on SmartAsset Blog.