The Best Portfolio Balance

What does the ideal investment portfolio look like? The answer, like the perfect diet, is there isn’t one. Much like a nutritionist considers diverse factors like age, activity level, and health goals when recommending a balanced diet, investors need to balance their portfolio with the following in mind: their financial situation, short- and long-term financial objectives, and tolerance for risk. Below, we explore how different life stages influence investment choices, discuss strategies for diversification, and discuss how to adapt your portfolio as your financial situation evolves.

A Balancing Act

A former client once said her overriding investment objective was to “maximize my return while minimizing my risk.” This is the holy grail of investing. She could have said, “I want to make good investments,” which would have been just as helpful. As long as humans continue to vary in age, income, net worth, desire to build wealth, propensity to spend, aversion to risk, number of children, hometown with a specific cost of living, and a million other variables, there’ll never be a universal portfolio balance that’s optimal for everyone.

Nevertheless, general advice is germane to people in particular life situations to align risk tolerances is available. Older adults who invest like 20-somethings, could find themselves without the dividend income they need, and parents who invest as singles are everywhere. However, they’re cheating themselves out of untold returns every year.

Your 20s: Fortune Favors the Bold

If you recently graduated college and did so without incurring significant debt, congratulations. If you did incur debt, then depending on the interest rate you’re being charged, your priority should be to pay it off as quickly as possible despite the relatively short-term pain.

If you’re ever going to invest aggressively, this is the time to do it. Yes, index funds are the ultimate safe stock investment and attract those who are risk-averse. The S&P 500’s returns over time are a testament to the value that can be accumulated over time. Learning about dollar cost averaging and beginning the habit of automated investing is also important for new graduates. Still, why not incorporate a little more unpredictability into a part of your investments in the hopes of building your portfolio faster?

Given a longer investment horizon, you have the time to recover from market downturns and investment decisions gone awry. Consider assigning a greater portion of your portfolio to stocks, especially growth stocks or exchange-traded funds linked to them, which historically offer higher returns (in exchange for greater risk).

The power of compound interest means that money invested in your 20s will grow substantially over time. Start with what you can afford, even if it’s a small amount, and increase what you set aside for your portfolio as your income grows. Automating your investments, such as setting up regular contributions to a retirement account like a 401(k), individual retirement account (IRA), or other funds in your portfolio, could ensure consistent growth and build a habit of saving.

Your 30s and 40s: Risk Tolerance Decreases

Most investors decrease their tolerance for risk as they enter their 30s and 40s. At this point, you’re likely less willing to bet major portions of your portfolio on single investments. If you have children: congrats again! It will bring you joys few things can. But with children come worries about their future. At this point, it’s important to start saving for their education with tax-advantaged accounts like 529 plans. However, you won’t be doing your kids any favors if you neglect your retirement savings. Consider prioritizing contributions to your retirement accounts, since there are lower-interest loans for education but not for retirement. Balancing these goals may mean you finally check that box off your to-do list and get with a financial advisor to create a plan that addresses both needs effectively.

As your responsibilities increase, balancing growth against risk becomes key. Continue investing in stocks, but start incorporating more bonds and fixed-income assets to reduce volatility. Diversification across different asset classes, including real estate or mutual funds, can help manage risk while still providing prospects for growth. You should also try to build a liquid fund for emergencies while also continuing with your automated investments for the long term.

As you’re becoming a seasoned investor, you might be more interested in many of the market’s targeted customized investments like target-date retirement funds and target-risk funds. These investors may also seek value versus growth with the former offering income while the latter rounds out some of their higher-risk allocations.

Approaching Retirement: Fortune Doesn’t Favor the Reckless

Fortune doesn’t favor the reckless, and hopefully, by your late 50s and early 60s, you’ve made good headway in saving for retirement. Start planning for income streams that will support you once you retire. You’ll likely start shifting your portfolio toward more conservative investments. Increase your allocation of bonds, dividend-paying stocks, and other stable income-generating assets. This could include annuities, government bonds, or dividend-paying investments. It’s also a time to reassess your risk tolerance and investment goals, moving toward assets that offer more liquidity and lower volatility. These shifts can help preserve your accumulated portfolio while providing growth to counteract inflation.

For retirement, it can be best to start with the three traditional classes of securities—in decreasing order of risk (and of potential return): stocks, bonds, and cash. (If you’re considering investing in esoteric investments like credit default swaps and rainbow options, you’re welcome to sit in on the advanced class.) The traditional rule of thumb—it’s overly simple and perhaps outdated—is that your age in years should equal the percentage of your portfolio invested in bonds and cash combined.

Once retired, your focus shifts to preserving the accumulated capital and generating a steady income. A larger part of your portfolio should be in low-risk, income-generating investments. Fixed-income securities, like Treasury bonds or high-quality corporate bonds, and conservative dividend stocks can provide steady income while preserving your capital.

Along with your investment portfolio, planning for estate and potential healthcare needs is essential. Consider long-term care insurance to cover potential healthcare costs and work on estate planning, including setting up trusts and ensuring your will is up to date. This is the somewhat grim last stop in the life cycle of portfolio planning.

Factoring Tax Obligations into Portfolio Planning

Accounting for your specific tax situation is crucial for maximizing your after-tax returns and increasing the size of your portfolio over time. Here are some general points you should consider in portfolio planning:

• Place investments that generate high taxable income, like bonds or high-dividend stocks, in tax-deferred accounts like IRAs or 401(k)s). Investments with lower tax implications, such as stocks held for long-term capital gains, can be placed in taxable accounts.
• Determine how different investments are taxed differently. For instance, long-term capital gains and qualified dividends typically receive lower tax rates than ordinary income.
• Consider municipal bonds for tax-free income. Investing in municipal bonds can be particularly beneficial if you’re in a higher tax bracket. The interest from these bonds is often exempt from federal taxes and sometimes state taxes, making them an attractive option for tax-efficient income.
• Tax-loss harvesting is making lemonade from lemons in the market. You sell investments at a loss to offset capital gains from other investments, thus lowering your taxes.

For these and other tax strategies related to balancing your portfolio, it’s best to seek professional tax advice from a tax professional or financial advisor experienced in this area. Tax laws can be complex and apply differently based on your circumstances.

The Bottom Line

The general rule of thumb is the more life you have ahead, the more of your money that should be held in stocks (with their greater potential for growth than bonds and cash have.) This neglects to mention that the more wealth you have, irrespective of age, the more conservative you can afford to be. The inevitable corollary might be less obvious, but it goes like this: the less wealth you have, the more aggressive you might need to be.

Investing isn’t like chemistry, where the same experiment under the same conditions leads to the same result every time. However, you can rely on some basic principles, mainly centered around age and risk. Understanding and creating a portfolio allocation using stocks, bonds, and cash that aligns with your risk tolerances and short-term versus long-term needs is important. From there, you could broaden your investments to alternatives like real estate or take some concentrated high-risk investments in high-growth stocks to reach higher returns. The best portfolio balance will fit your risk tolerance, goals, and evolving investment interests.