Daily Gains Letter

Asset Allocation Key to Successful Investing: Guidelines for Investing as You Grow Older

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Asset Allocation Key to Successful InvestingThe 460-point intraday swing in the DOW on Tuesday could be reflective of what to expect this year. While I was sitting at my trading desk, I was thinking how the volatile swings in the stock market would likely scare the average investor.

Recently, my dad called and asked me what I thought about the state of the stock market. My immediate answer was that it really shouldn’t matter that much to him at this juncture in his life. Now, I’m not saying my dad shouldn’t worry, but he should be largely invested in lower-risk income-producing investment vehicles, such as the banks and utilities, along with higher-yielding bonds anyway.

And that leads me to an important point: the key to successful investing is to understand where you are in your investment lifecycle. Those who are older should have security and income in mind, while younger investors should have growth in mind. An older investor thinking about retirement shouldn’t assume the same amount of risk as a younger investor. The opposite is also true: a younger investor shouldn’t be primarily buying bonds and lower-beta, low-return stocks.

The Best Investment Strategy Based on Age and Risk Profile?

What you need to keep in mind is the concept of a sound asset allocation and diversification strategy that makes sense and fits your priorities based on your age. The idea of asset allocation should be a key part of any prudent investment strategy. Without a plan, you are vulnerable to market shocks that may be insurmountable.

When I talk about asset allocation, I’m referring to the asset mix of your portfolio divided into three major areas: cash, fixed income, and equities.

In an ideal asset allocation model, you don’t want to be at the extremes. Too much cash over a few years translates into a lower overall return, but excess equities could mean too much exposure to risk. You want to be somewhere in between, but where exactly ultimately depends on your age and risk profile.

And as the investment climate changes, you should rebalance your asset mix and modify your investment strategy. For most investors, put options should be used as a hedge against weakness.

The simple rule is this: the older you are, the less you should be exposed to higher-risk equities. Imagine being invested heavily in equities as you near retirement and stocks fall into a bear market; in that instance, you may not be able to recover, having to push back your retirement plans because you simply don’t have enough money saved. Clearly, that’s not a sound investment strategy.

While there are no hard and fast rules on asset allocation, there are some guidelines you can consider.

Guidelines for Asset Allocation

At 25 Years Old: An appropriate asset allocation strategy would be to invest up to 75% in equities; the remaining 25% should be held in cash and cash equivalents that can be sold for opportunities that may surface.

At 50 Years Old: The prudent asset allocation strategy would be to consider cutting down your exposure to stocks to around 50%, depending on your risk profile and financial situation.

At 65 Years or Older: As I touched on earlier, as you near retirement, you really need to be prudent with your investment choices for asset allocation and consider how a downturn in stocks could impact your financial situation.

Ultimately, if you are older and love stocks, then the best strategy may be to invest in blue-chip, dividend-paying stocks that have proven to be consistent in the past, such as The Procter & Gamble Company (NYSE/PG) and Colgate-Palmolive Company (NYSE/CL).

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