Candidates For The Financial Samurai Asset Allocation:
- Have multiple income streams.
- Are a personal finance enthusiast who gets a kick out of reading finance literature and managing your money.
- Not dependent on your 401k or IRA portfoliso in retirement, but would like it to be there as a nice bonus.
- Enjoys studying macroeconomic policy to understand how it may affect your finances.
- Is an early retiree who wont be contributing as much to their portfolios as before.
- Also invests in real estate to diversify and smooth out the volatility of stocks. Real estate is actually my favorite asset class to build wealth because it is easy to understand, is tangible, provides utility, and has a solid income stream.
- Given a Financial Samurai is a real estate investor, real estate acts as a Bonds Plus type of investment. In other words, real estate is defensive during a downturn as more capital goes towards real assets. Real estate also tends to do well as more investors buy bonds, resulting in lower interest rates. At the same time, real estate tends to do well during strong economic growth due to rising rents and rising real estate prices.
Why Is Diversification Important For Investment Strategies
Diversification is essentially the investment strategy version of “don’t put all your eggs in one basket.” The idea is that by diversifying your funds across many different types of investments, there is a higher chance of something doing well in a given day, month, or year. One or two stocks you own might be down one day, but others may be up. This makes it less jarring to look at your account because the price fluctuations won’t be as volatile.
Active Vs Passive Management
Investors today have more choices than ever when it comes to who can manage their money. One of these choices is active vs. passive portfolio management. Many planners exclusively recommend portfolios of index funds that are passively managed.
Others offer actively managed portfolios that may post returns that are superior to those of the broader marketsand with less volatility. However, actively managed funds typically charge higher fees, which is important to consider since those fees can erode your investment returns over the years.
Another option is a robo-advisor, which is a digital platform that allocates and manages a portfolio according to preset algorithms triggered by market activity. Robo-advisors typically cost far less than human managers. Still, their inability to deviate from their programs may be disadvantageous in some cases. And the trading patterns they use are generally less sophisticated than those employed by their human counterparts.
Robo-advisors may not be the best choice if you need advanced services such as estate planning, complicated tax management, trust fund administration, or retirement planning.
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When Should You Be In A Balanced Portfolio
There are no hard and fast rules as to the type of investments each individual should choose. There are, however, typical situations when balanced portfolios are a good option. Bear in mind that you may not achieve the highest returns as markets tick upward. That said, as mentioned above, you may also avoid losses in market downturns because of a balanced portfolio allocation.
Consider a balanced portfolio if your situation is like any of these:
- Youre not experienced in investing and want a good compromise between achieving long-term goals while avoiding high risk.
- As a retiree, you feel comfortable with accepting variances in your account based on market performance.
- You are in a younger age category with goals like as buying a home or saving for a major vacation 5 to 10 years down the road.
- Your investment runway is long but you dont want to weather big fluctuations in your account over time.
How Often Should You Rebalance Your Portfolio
You’ll often hear that you should rebalance once or twice a year , and that’s fine for most investors. That said, markets are largely unpredictable, and rebalancing at an arbitrary time of the year could put your money at risk if you leave your portfolio alone after big market moves
Instead, a smarter approach may be to follow a 5% rule — simply keep an eye on your portfolio every quarter, or at the very least after huge market moves, and make sure your assets are within 5% of where they should be when you last planned your portfolio.
For example, if your portfolio started with 80% in stocks and they do so well over the next four months that your holdings change to 85% or more in stocks, it’s time to rebalance. Or, if your stocks do poorly and your holdings change to 75% or less in stocks, it’s time to rebalance. The idea is to not let your asset classes change more than 5% of where they’re supposed to be. That will keep you on track.
Of course, there are always exceptions. Your ‘original’ portfolio plan may become outdated every 10 years as you approach retirement — what was right for you then may not be right for you now.
For example, a 30-year-old may want more stocks than a 40-year-old. And a 50-year-old may want more bonds .
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Asset Allocation And Risk Tolerance
Investor behavior plays a big part in asset allocation in the form of risk tolerance. A successful asset allocation strategy requires that the investor is able to stick to it. Modern Portfolio Theory assumes all investors behave rationally and unemotionally. We know this isnt the case.
The investor is usually the cause of the failure of their investment plan, not the financial markets. As you might imagine, plans are typically abandoned during crashes or extreme bull markets. One of the mistakes most often made is the overestimation of ones tolerance for risk. Risk tolerance can be defined as the point at which price volatility or drawdown causes you to change your behavior. Obviously, for a young investor with no experience, this point can be hard to assess.
Stocks are more risky than bonds. Buying stocks is a bet on the future earnings of companies. Bonds are a contractual obligation for a set payment to the bond holder. Because future corporate earnings and what the company does with those earnings are outside the control of the investor, stocks inherently possess greater risk and thus greater potential reward than bonds.
William Bernstein suggested that an investor can evaluate their risk tolerance based on how they reacted to the Global Financial Crisis of 2008:
- Sold: low risk tolerance
- Held steady: moderate risk tolerance
- Bought more: high risk tolerance
- Bought more and hoped for further declines: very high risk tolerance
Consider Saving In A Roth Account
Withdrawals from Roth IRA and Roth 401 accounts are tax-free in retirement, provided you have held the account for at least five years and are age 59½ or older. Roth contributions are made with after-tax money, making them ideal for workers who expect to be in a higher tax bracket in the future. If you are starting your career, its likely your earnings will increase and youll be in a higher tax bracket later, making Roth contributions a better strategy for many millennials today, explains Ward.
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Look At Your Overall Portfolio
To get an accurate picture of your investments, you need to look at all your accounts combined, not just individual accounts. If you have both a 401 and a Roth IRA, you want to know how they are working together. What does your combined portfolio look like? Obviously, youll skip this step if you only have one investment account.
Use one of these three methods to create a combined picture of all your investment accounts.
Don’t Like Rebalancing Your 401k Use Target Date Funds For Simplicity
One more tip: If you’re invested in a 401k plan and rebalancing your portfolio sounds like too much of a hassle, consider simply investing in a target-date fund if your 401 provider offers them.
Target date funds are simply mutual funds that are set up to match your age and risk tolerance and automatically rebalance your investments as you approach retirement. You can learn more about these super-simple funds in .
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How Do I Rebalance My Portfolio
The purpose of rebalancing is to ensure your investment portfolio is correctly weighted to suit your risk tolerance and financial goals. If you feel that your portfolio has become too risky or too conservative, you can take action to return it to your original asset allocation target by selling something youre overweight in and replacing it with whatever is lacking.Alternatively, if you dont want to sell, consider depositing extra funds or using dividend payments to purchase more of the investments youre underweight in until your portfolio meets your objectives again.
What Can Affect My Asset Allocation
Your risk tolerance stands as a crucial factor when determining the right asset allocation. If yours is very low, then you may want to invest conservatively until youve developed an appetite. If youre not sure where you stand, you can use our asset allocation calculator. It gives you a glimpse into a potential asset allocation based on your risk tolerance.
Furthermore, you should also take a serious look at your health. Health costs are rising across the board. But if youre not maintaining a healthy lifestyle now, you can expect some hefty medical bills when youre near or in retirement. One way to start saving for future medical costs now is to invest in a health savings account . Youd need to pair it with an eligible high-deductible health plan . But these offer some serious tax and savings benefits. They provide the following perks.
- Pre-tax contributions that reduce your taxable income
- Tax-free growth on your investment
- Tax-free withdrawals for qualified health expenses
Plus, you can open one at most major banks. Some investment firms also offer HSAs that invest in mutual funds and other securities. In fact, some investors see HSAs as effective components of an overall retirement-planning strategy.
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Managing The Size Of Your Portfolio
As your portfolio size grows larger during the accumulation phase , it might make sense to start to use some of the money from the funds to invest across numerous different types of accounts.
Common financial guidance is to have the stock percentage of your portfolio match the number 100 minus your age . According to this rule, if you are 50 years old, you should have 50% of your assets in stocks. In this manner, you transfer your assets out of stocks as you get older, making sure that a growing percentage of your investments have less risk while keeping the rest in money-earning investments.
In the distribution phase , if you have a larger portfolio size and numerous types of accounts, you may want to use a bond ladder so that the bond portion of your portfolio lines up in each account with the number of withdrawals you will need from that account. You will not be able to do this with a balanced fund, so you might need to roll the account into an investment with more liquidity when you begin to consider retiring.
Conventional Asset Allocation Model For Stocks And Bonds
The proper asset allocation of stocks and bonds generally follows the conventional model.
The classic recommendation for asset allocation is to subtract your age from 100 to find out how much you should allocate towards stocks. The basic premise is that we become risk averse as we age given we have less of an ability to generate income.
We also dont want to spend our older years working. We are willing to trade lower returns for higher certainty. The following chart demonstrates the conventional asset allocation by age.
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Don’t Reach For Yield
It may be tempting to look for the investments offering the highest dividend or interest rate. But as the old saying goes, there’s no free lunch the higher the rate, often the higher the risk of the investment. Instead of chasing the highest-yielding investment, look for companies that have a track record of growing their dividends over time.
Beginners Guide To Asset Allocation Diversification And Rebalancing
Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn them? Through ordinary, real-life experiences that have nothing to do with the stock market.
For example, have you ever noticed that street vendors often sell seemingly unrelated products – such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never – and thats the point. Street vendors know that when its raining, its easier to sell umbrellas but harder to sell sunglasses. And when its sunny, the reverse is true. By selling both items – in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.
If that makes sense, youve got a great start on understanding asset allocation and diversification. This publication will cover those topics more fully and will also discuss the importance of rebalancing from time to time.
Lets begin by looking at asset allocation.
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Reasons To Change The Rules
Pretty straightforward, right? Not necessarily. While an easy-to-remember guideline can help take some of the complexity out of retirement planning, it may be time to revisit this particular one. Over the past few decades, a lot has changed for the American investor.
For one thing, the life expectancy here has steadily risen. The average American lived to about 77 years in 2020 compared to just over the age of 76 in 2000, according to data from the World Bank. What’s the lesson here? Not only do we have to increase our nest eggs, but we also have more time to grow our money and recover from a dip.
At the same time, U.S. Treasury bonds are paying a fraction of what they once did. As of May 2022, a 10-year T-bill yields 2.75% annually. In the early 1980s, investors could count on interest rates upwards of 10%.
Make sure you consult a financial professional when undertaking any investment strategy and before you make any investment decisions.
The Three Asset Classes
Fundamentals. Theyre crucial for success in everything you do. Whether youre building a home, learning jiu-jitsu, or whipping up a marinade for your steak, specific criteria must be met.
A well-balanced portfolio is no different. Whether its something you constructed yourself or your financial advisor built for you, youll most likely see these three asset classes:
- Stocks
- Bonds
- Cash
There is usually very little correlation, and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing. Investopedia
The success of one wont affect the other. For example, if all your money is in the stock market and it tanks, you could lose a lot.
Even worse, it could take years before your portfolio recovers. What if youre near retirement and cant afford to lose it?
Thats why diversifying your portfolio with a mix of stocks, bonds, and cash is a fantastic idea and a core part of most portfolios.
You could even go further by adding real estate investments, futures, commodities, and other financial derivatives. But thats another article.
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Tip : Consider All Your Income Sources
As you put together your retirement portfolio, you also need to think about the role your savings will play in your overall income plan. For example, how much income do you expect from guaranteed sources like annuities, pensions, and Social Security?
If these guaranteed income streams will generate enough income to cover the majority of your expenses, you might be able to maintain a more aggressive stance with your portfolio well into retirement, Rob says. Conversely, if youll rely on your portfolio for the majority of your income, youll need to take a more balanced approach with your investments.
Here’s What It Means To Construct A Balanced Portfolio And How To Make Sure Your Portfolio Stays That Way
Balancing your portfolio means constructing a portfolio that fits your individual risk tolerance and investment goals. But it isn’t enough to just “set it and forget it.” You also need to make sure your portfolio stays balanced, which is known as rebalancing.
Here’s a quick summary of what investors should know about balancing and rebalancing an investment portfolio:
- Balancing your portfolio ensures that you have a mix of investment assets — usually stocks and bonds — appropriate for your risk tolerance and investment goals.
- Rebalancing your portfolio allows you to maintain your desired level of risk over time.
- Portfolios naturally get out of balance as the prices of individual investments fluctuate over time.
- You can rebalance your portfolio at predetermined time intervals or when your allocations have deviated a certain amount from your ideal portfolio mix.
- Rebalancing can be done by either selling one investment and buying another or by allocating additional funds to either stocks or bonds.
With that in mind, what is the goal of balancing and rebalancing your portfolio, and why is it so important?
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Review Your Asset Allocation
Retirement can last up to three decades or more, meaning your portfolio will still need to grow in order to support you. Exposure to stocks should remain an important part of your allocation target, even in retirement. However, a possible need to access these assets for income in the near term means you are more susceptible to short-term risks. Thats why its important to position your portfolio to add more exposure to bonds and cash.
No matter your age, you can take steps now to ensure that you are ready for retirement. The key is to make retirement savings a priority early on and then maintain that focus throughout your working years. Even after youve retired, remain focused on a sustainable plan that will help support you through this time of your life.
Asset Allocation in Your 50s, 60s, and 70s
As you near retirement, your portfolio will move gradually from more aggressive to more conservative.
Asset Allocation Models:
