Asset allocation by age refers to a strategy of investment portfolio management by which individuals use their age to determine the types of investments they have. The general rule is that older people should assign more of their investments to reliable securities like bonds. Younger people can afford to purchase riskier securities like stocks simply because they have more time to recover losses before they need the money for retirement. There are many different strategies used for asset allocation by age that are best determined according to the circumstances of the individual.
Many people use their investments in different securities as the basis for providing for themselves and their loved ones at a point at which they can no longer earn income comparable to their younger years. Choosing between securities is often the focus for investors, but it can be just as important for them to decide how much of the money in a portfolio is devoted to different types of securities. This is a process known as asset allocation, and asset allocation by age is one such method of determining a portfolio's investments.
The basic premise behind asset allocation by age is that, as an individual ages, there should be a shift in her asset allocation from a larger percentage of stocks to a larger percentage of bonds. Stocks offer the potential for greater growth over a long period of time, which helps to offset the risk they contain. Younger people need to build the wealth in a portfolio, which is why stocks are the better choice for them.
As people begin to get older, the asset allocation by age theory requires that more of the capital within a portfolio be devoted to steadier securities like bonds. Bonds may offer limited growth, but they also contain minimal risk. The capital within the bonds will be safe for older people who may need it as a source of income for daily living. They also offer small returns from interest that are generally unaffected by inflation.
One rule of thumb that some use when practicing asset allocation by age is to divide the stocks and bonds in a portfolio according to a person's age in years. For example, a 30-year-old person should have 30 percent of his portfolio in bonds and the remaining 70 percent in stocks. If a portfolio is held by a couple, taking the average of their ages can be used as the benchmark for portfolio decisions. Many people use age as one determining factor while also taking into account their financial situation and their need based on cost of living.
