Q: How much of my investments should be in stocks, and how much in bonds?
Whether you're investing in a 401(k), an IRA, or are simply investing in your own brokerage account, the basics of asset allocation are important to know. There are thousands of different investments you could make in these accounts, but they generally fall into three main categories:
- Stocks (also called equities)
- Bonds (also called fixed income)
- Cash (CDs, money market, etc.)
As long as you have some cash set aside for emergencies in savings, I don't advise keeping too much of your investing dollars in cash, unless you're already retired. So, let's discuss stocks and bonds.
Stocks are generally more volatile than bonds, but also offer the highest long-term return potential. For this reason, younger investors who have time to ride out the market's ups and downs should have more money in stocks than older investors.
On the other hand, bonds have lower volatility and produce consistent income, but have lower growth potential, making then more appropriate for older investors who may need their money soon. To be clear, bonds are not risk-free, as many new investors mistakenly believe -- if interest rates rise, the market value of most bond investments will fall. Plus, there's always the risk of the bond issuer defaulting to consider.
A general rule of thumb that I use is to subtract your age from 110 to determine how much of your portfolio should be invested in stocks, with the rest invested in bonds. For example, if you're 35 years old, this implies that 75% of your investments should be in stocks and 25% in bonds. If you have a higher appetite for risk, you can adjust this in favor of stocks, and if you're a more conservative investor, you can make your portfolio more bond-heavy.
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