http://www.getrichslowly.org/blog/2009/12/30/getting-started-with-asset-allocation/
http://www.getrichslowly.org/blog/?p=8033
This is a guest post from Dylan Ross, a certified financial planner and a long-time GRS reader.
If you’re new to investing, recognize the merits of using low-cost index funds, but you’re not sure how to allocate your long-term savings among various types of index funds, this information is for you.
Asset allocation basics
While there are many ways to divide investment assets into different categories, there are two main classifications: stocks and bonds.
Here’s what you need to know: Stocks are riskier but have the potential for higher rewards compared with bonds. Also, stocks and bonds don’t always move up or down together. That’s it. That’s enough info to get you started. There’s plenty more to learn about stocks and bonds if you want, but you needn’t wait any longer to start investing.
The starter asset allocation
If you’re just getting started, here’s a fine way to allocate your funds until you’re ready to make things more complex:
- 60% in a total US stock market index fund
- 40% in a total US bond market index fund
The biggest criticism I hear over this approach is that it’s too conservative for younger investors and to aggressive for older investors. My response: Then change it to 80% stocks/20% bonds (for young investors) or 40% stocks/60% bonds (for older investors) if that’s the conclusion you’ve reached.
Another criticism is that there’s no international (or emerging markets, REITs, TIPS, or whatever else you like). Okay, so add them if you want and can satisfy fund minimums. Use the starter allocation as a starting point. As your knowledge, understanding, and comfort level increase, feel free to make changes.
If you’re just starting out without a lot of money, the greatest influence on your account balance will not come from your asset allocation; it will be your own contributions. If having 20% in international stocks would have earned you an extra half percent on your $5,000 portfolio your, you missed out on $25. (And it could just as easily cost you half a percent, in which case you saved $25.)
When your balance is small, what you contribute matters more than what you contribute to. You may even reach the conclusion that the 60/40 starter allocation is works for you long-term.
If you don’t have enough money saved to meet the minimum investments, then save in a high-yield savings account until you do. (For example, you can implement the starter allocation using VBINX with $3,000.)
Next steps
Once you have more money invested for longer periods of time, asset allocation decisions become more significant. Just keep in mind that increased stock market exposure doesn’t always mean a greater chance of achieving your financial goals. The added risk of additional stock may work against you, and in some cases can decrease you chances of achieving your financial goals. I’m not talking about market volatility; I’m talking about the very real chance of experiencing a less favorable, long-term outcome.
From here, you can continue to educate yourself about the effect of asset allocation on your own financial goals and priorities, or you can seek some help from a professional. And by seek some help from a professional, I’m not necessarily talking about having them manage your money; you can hire a financial planner just to recommend an appropriate asset allocation for you that you can implement yourself.
Previously at Get Rich Slowly, Dylan has written When and how to hire a financial planner, What is a financial plan (and why have one?), How lower fees and expenses with index funds could mean 33% more to spend in retirement.
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