Asset allocation by age: how to split your money between stocks, bonds and cash

Asset allocation is how you split your money between stocks, bonds and cash. It largely decides how bumpy your portfolio feels and how much it can grow, and some experts rank it above the choice of individual investments. This guide explains how to pick a mix, what target-date funds do for you, and how to keep the mix on track.

The three building blocks

• Stocks have historically offered the highest returns and the biggest swings. The SEC's beginners' guide notes that large-company stocks as a group have lost money in roughly one year out of three. Over long periods they are the main engine of growth.
• Bonds usually move less than stocks and earn less. Bonds and stocks often move in different directions, which is why bonds cushion a portfolio. Lower-quality, high-yield bonds behave more like stocks.
• Cash and cash equivalents (savings accounts, CDs, Treasury bills, money market funds) are the safest and earn the least. Their main risk is inflation quietly eating their value.

Because these do not all move in the same direction at the same time, holding several of them smooths the ride. Holding only one, even a diversified stock fund, leaves you exposed to that one market.

Time horizon and risk tolerance

Two questions set your mix.

When will you need the money? That is your time horizon. Money for a goal decades away, such as retirement, can ride out stock market falls. Money for a home down payment in two years cannot, so it belongs mostly in cash. FINRA makes the same point: different goals can have different mixes, even for the same person. Keep your emergency fund out of this calculation entirely; it stays in cash.

How much loss can you live with? That is your risk tolerance: both your ability to absorb a loss and your willingness to sit through one without selling. Someone with a steady job and a long horizon can usually take more risk than someone with irregular income. Online risk questionnaires can help, but the SEC notes they sometimes steer you toward the sponsor's products.

The SEC's guide warns about both extremes. Too little risk and your money may not grow enough to reach the goal. Too much and a crash just before you need the money can leave you short. Most experts agree a long-term goal like retirement needs some stocks.

Rules of thumb by age (and their limits)

A popular shortcut is the "rule of 110": subtract your age from 110 and hold that percentage in stocks, with the rest in bonds. At age 30, 110 minus 30 gives 80% in stocks. More aggressive versions use 120 instead of 110.

Treat these as rules of thumb only. They know your age and nothing else: not your goal, your job security, your other savings, or how you reacted the last time markets fell. The SEC says it cannot endorse any formula and that no single mix suits everyone. Use a rule as a starting point, then adjust it for your situation.

Target-date funds: allocation on autopilot

A target-date fund puts the whole job in one fund. You pick the fund whose year matches roughly when you expect to retire (for example, a fund labeled 2060 for someone retiring around 2060). It typically holds other funds, a mix of stock and bond funds, and gradually shifts from stocks toward bonds as the date approaches. That schedule is called the glide path. The fund also rebalances for you.

What to check before you rely on one:

• "To" or "through". A "to" fund reaches its most conservative mix at the target date and stops there. A "through" fund keeps shifting for years after it. At many points a "to" fund holds less in stocks.
• Funds with the same year can be very different. Strategy, stock share, glide path and fees vary by provider, so their results can too.
• Fees can stack. You may pay the target-date fund's fee plus the fees of the funds inside it. Read the fee table.
• No guarantee. A target-date mutual fund or ETF does not promise any level of retirement income.
• You can pick a different year. If you want more or less risk than the default, a fund with an earlier or later date is a simple way to adjust. Employers sometimes enroll you in the plan's target-date fund automatically, so check which one you hold and whether it fits.

One more rule: a target-date fund is built to be your whole portfolio for that account. Adding other stock funds next to it changes the mix it was designed to keep.

Rebalancing: calendar or threshold

Your mix drifts because each asset grows at its own pace. The SEC's example is a portfolio meant to be 60% stocks that climbs to 80% after a strong market. Rebalancing brings it back, which in practice means trimming what has done well and adding to what has lagged.

There are two common ways to decide when:

• Calendar. Check on a fixed schedule, such as every six or 12 months, and rebalance if the mix has moved. FINRA suggests considering it once a year as part of an annual review.
• Threshold. Rebalance only when an asset class drifts outside a band you set in advance, for example five percentage points either side of your target.

The SEC notes that rebalancing tends to work best when done relatively infrequently. Whichever you pick, decide it before markets move.

How you rebalance matters as much as when. Send new contributions to whatever is underweight first; that costs nothing. Selling inside a 401(k) or IRA has no tax effect, but selling winners in a taxable brokerage account can trigger capital gains tax, and some trades carry fees.

Worked example: rebalancing a $20,000 portfolio

Assumptions for illustration only: a $20,000 portfolio with a 80% stocks / 20% bonds target. Over a year, stocks return +25% and bonds +2%. No fees or taxes.

After a good year for stocks, the portfolio holds 83.1% in stocks, more risk than you chose. To get back to 80%, sell $736 of the stock fund and buy $736 of the bond fund.

If you would rather not sell, add new money to bonds instead. Putting $920 into the bond fund takes it to $5,000, which is 20% of a $25,000 portfolio, and no gains are realized. In a taxable account, that is often the cheaper route.

What to do this week

1. Write down each goal you are investing for and when you will need the money. Give each one a target mix.
2. Log in to your accounts and add up what you hold in stocks, bonds and cash across all of them. Compare it with your targets.
3. If you hold a target-date fund, check whether it is "to" or "through", its total fee and its current stock share.
4. Pick a rebalancing rule (a date or a drift band) and put a reminder in your calendar. For what to hold in each slot, see index funds and ETFs explained, and for where new money should go first, how to start investing.

General education, not personal financial advice. Figures are illustrations computed from the stated assumptions.