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Now that you know what history tells us about Stocks, Bonds and Cash, here is a framework for putting this to use. Consider the following example:
Practical Allocation Let’s assume that we have two investment accounts: the first account includes money we plan to spend over the next year; the second account, let’s call it account 25 has money that we know we won’t touch for at least 25 years. Given what we know about asset allocation, the first account should be 100% cash because the last thing we want to do is lose any of that money, and the account we won’t touch for 25 years should be 100% stocks, because stocks have clearly offered the best long-term performance potential.
25 Years Let’s extend the logic described above and think about the next 25 years as each having its own “mini” account. The first accounts (representing the money needed for next few years) should be 100% cash. The last accounts, with money we won’t use for 18 to 25 years, should hold all stocks. The middle accounts should hold a combination of stocks and bonds, as shown below:
Allocation Changes Over Time After five years, we’ll need to adjust our allocation because we will have a shorter time horizon. We will sell off some stocks and increase our allocation to cash and bonds. Our allocation is now 10% cash, 30% bonds and 60% stocks. The cash allocation has increased because we now have 20 years, not 25 years from our goal, and those same 2 years in cash now represent 10% of this 20-year period. We’ll continue to sell off the riskier portion of our portfolio and increase our allocation to cash and bonds as time passes. When we are just two years from our goal, we will be 100% in cash.
You can apply this same concept for setting up your allocation whether you’re investing to fund your retirement, investing to pay for a child’s education, or to potentially fund almost any other goal.
The information provided herein represents the opinions of the advisor, and is not intended to be a forecast of future events or a guarantee of future results, and does not constitute investment advice.