U.S. Government Tips for Investment Percentages
If you're hoping the U.S. government can tell you how to allocate your 401k, you probably won't find a definitive answer. Investment allocation percentages depend on personal financial goals. The Securities and Exchange Commission and the Department of Labor have published some great primers to educate investors about investment concepts. But other than making broad references to the reasons you should allocate your investments, government sources avoid specific recommendations about investment allocation percentages.
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Asset Allocation Basics
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Asset allocation refers to your decisions about how to divide your investment dollars among the investment categories, generally stocks, bonds and cash. Each category can be divided even further. For example, you can purchase large-company stocks or small-company stocks. Cash investment choices include CDs, money market funds and fixed annuities. Each type of investment carries certain risks and rewards. Only you can judge which risks you are willing to take. Your asset allocation strategy generally depends on the number of years you plan to hold your investment. If you won't use your investment money for 25 years, you might want to invest in riskier stocks. Over time, stocks earn more than bonds or cash, but they can rise and fall over short market cycles. If you are close to retirement, you may want to overweight bonds. More stable than stocks, they also pay consistent dividends to supplement your retirement income.
Why Asset Allocation is Important
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The asset categories generally do not move up or down together. Each tends to follow a market cycle. By combining the three categories in your investment portfolio, you may reduce your overall investment risk and smooth the sharp see-saw in stock prices to a more tolerable ebb and flow. If fear keeps you from investing in stocks at all, you run the risk that the safer cash investments will not allow your nest egg to grow faster than inflation.
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Understand Your Goals
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Analyze your financial goals. Use retirement calculators to determine how much money you need to accumulate to lead the retirement lifestyle of your dreams. The calculators generally factor in your investment time frame. Based on that number, the calculator indicates a recommended monthly savings goal with an average annual rate of return to meet your goal. Once you know those numbers, you can develop an asset allocation plan that blends stocks, bonds and cash to maximize your earnings and minimize your overall risk.
Risk and Reward
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Blend your investment percentages based on the average long-term returns of the asset categories. The DOL points out that stocks averaged an 11.3 annual return since 1928. One dollar invested in stocks in 1928 would have grown to $6,495. Cash equivalents would have averaged 2.2 percent during the same time frame, growing to $20. After inflation, however, you'd have about $14 left in purchasing power. Bonds averaged a little better at 5.2 percent with a dollar growing to $63. With such an obvious advantage to long-term exposure in stocks, you should direct a percentage of your retirement investments toward stocks. Make sure you understand the investment and feel comfortable with your choice. Unfortunately, the government is not in the investment advisory business. However, a financial adviser can help you choose appropriate percentages tailored for your specific circumstances and personality.
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