Ideal Asset Allocation in Retirement: 60/40 vs. 70/30

The foremost step for effective financial planning is asset allocation, where the right combination of asset classes is chosen after careful evaluation of  several factors such as the risk profile, future goals, investment horizon, the prevalent rate of inflation, and more. However, when you add retirement to  the equation, it may get a little more complicated.

With that said, you need to not fret as you can employ some time-tested asset allocation strategies that can help decide your risk exposure levels and the right mix of assets easily and more effectively. The most popular asset allocation strategies are said to be the 70/30 rule and the 60/40 rule. If you wish to learn more about asset allocation strategies and find out which strategy would be more suitable for you as per your risk appetite and investment horizon, reach out to a professional financial advisor who can advise you on the same.

You may have certain questions in mind at this stage such as what do the numbers represent in the said asset allocation strategy, how are those numbers determined to arrive at the best retirement portfolio allocation, and most importantly of all, have investors benefited from these strategies in the past? Read further to know more.

What is asset allocation?

One of the primary principles of investing is asset diversification. It is unwise to have just one kind of asset in your portfolio as it makes you vulnerable to risk, should the market undergo a period of volatility. Hence, diversification is necessary, as it not only helps dilute overall portfolio risks but also helps generate higher returns.

In asset allocation, a portfolio is constructed keeping in mind the risk profile and investment goals of an individual. Typically, asset allocation may remain spread over asset classes ranging from stocks, bonds, commodities, liquid cash, real estate, and more. But how can one effectively diversify their portfolio? How should one determine the right mix of asset classes?

After carrying out extensive analysis and experiments, financial analysts have come up with certain rules and strategies concerning asset allocation that hold true for people having similar financial conditions and risk profiles. While it is always considered suitable to get your personal situations analyzed by a financial advisor when making investment decisions, the basic starting point or benchmark for asset allocation has come to be designed around certain rules.

Usually, a combination or exposure percentage to stocks and bonds represent the number 70/30 and 60/40. Here, the numbers 70 and 60 represent stock exposure, whereas the numbers 30 and 40 represent exposure to bonds. These numbers are read together to give an individual the approximate percentage of exposure they should have to stocks and bonds, respectively.

However, why must we pick only between stocks and bonds?  There are two reasons for this approach:

  1. Stocks and bonds are considered as ‘traditional assets’ and it is quite possible to create an entire portfolio comprising of just these two assets.
  2. Stocks and bonds are markedly different from each other in various respects such as risk exposure, their functioning, as well as return generation capacity. In fact, they share an inverse relationship. When stocks go down, bonds tend to do well, and vice-versa.

Let us now read each of these golden rules in detail.

What is the 70/30 rule?

The 70/30 rule represents an asset allocation strategy wherein an individual shall have 70% stock exposure in their portfolio. The remaining 30% may be allocated to bonds. Now, it is well known that equities are a risky asset class. On the other hand, bonds have historically been safer with stable returns. Given equities have a higher allocation in the 70/30 rule, this strategy may be more suited to  individuals who have a higher risk appetite. That said, financial advisors generally tend to suggest including a little equity in every portfolio to capitalize on its potential as a wealth multiplier.

Within this 70%, an individual may either pick direct equities, equity mutual funds, ETFs or any other equity and equity related products. They may choose the most aggressively growing stocks or a high dividend yielding stock. But if the individual is close to retirement, a combination of more stable equity such as large-cap stocks, blue-chip stocks, mutual funds or index funds may be safer options for this kind of a risk profile. The 30% exposure to bonds buffers the risk of 70% equity exposure to some extent, besides providing stable returns.

While asset allocation is generally governed by various factors including demographics and economics, the 70/30 rule may serve as a good starting point for most investors. Investors who have higher risk tolerance and are in their 20s/30s can benefit from the 70/30 rule. Returns from equities can compound themselves over time, giving good returns right before retirement. You may use this rule as a starting point and change the percentages as per your discretion.

What is the 60/40 rule?

The 60/40 rule is not very different from the 70/30 rule. The only difference here is that the exposure to equities stands at 60%, while the allocation to bonds stands at 40% exposure. Essentially, this rule gives greater importance to stability and is suitable for risk-averse individuals. However, it must be noted that though bonds will make up 40% of the portfolio, equity allocation is still higher, at 60%.

Investors in their 40’s/50’s with a moderate risk profile may find this strategy to be more viable. These folks are closer to retirement, hence,  they may prefer to focus on capital preservation over wealth accumulation as that may put their existing money at risk.

Both 70/30 and 60/40 have more than 50% exposure to equities. So, are these rules viable for individuals who are retired or fast approaching retirement?

Let us find out.

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What do you need to keep in mind before zeroing in on a strategy?

While all investment strategies primarily aim for risk dilution and profit maximization, you, as an investor, need to understand that these strategies are heavily influenced by various factors and circumstances.

Let’s take a closer look at what some of these factors may be.

1. Risk

Risk is the primary building block of any investment strategy. Based on this risk, strategies are demarcated into numbers of 70/30, 60/40, etc. It will be in accordance with your risk profile that you may be required to choose a strategy/number.

If you are somebody who is highly risk-averse, even a 60/40 asset allocation may not be suitable. Here, a combination of 80% to 90% to bonds and other government securities may be more viable. This means that your assets will have 80% allocation or exposure to safer securities and the rest in equities. On the other hand, if you have a good risk tolerance, the opposite may also hold true.

But in essence, if closely observed, you may find that risk tolerance plays a critical role in determining asset allocation and exposure percentages for an individual.

2. Age

While risk may essentially guide asset allocation strategies for most, it is age that guides risk.

A young adult in his 20s or 30s may have higher risk tolerance compared to someone who is in their 50s or 60s and fast approaching retirement. This is because young individuals have time on their side and can stay invested for a longer period of time or work towards building an alternative income for themselves. You can take a more riskier approach when it comes to investment and invest your money in assets like stocks, precious metals, real estate, cryptocurrency, etc. Here, an asset allocation with more than 85% exposure to equities may be considered as viable.

While individuals in their 50s and 60s can also choose to invest in equities in large percentages, the risk factor may not be quite viable. Losses here can wreck financial planning for decades. Hence, age plays an important factor when deciding asset exposure.

3. Market volatility

Markets are largely unpredictable. Very few investors could predict the dot-com crisis,  the housing bubble crash, or the Covid-19 pandemic. Consider a grim scenario where you had planned to retire during such turbulent times. You may suddenly find out to your horror that your investments have bottomed out and your losses are sky-high, with bonds being the only counter, balancing the losses.

Now, what do you think your asset strategy would appear like – any plans of withdrawal that you’d have earlier will have to be put on hold. You will need to wait for the markets to pick up to generate returns or at the very least recoup some of your losses. At this time you should focus on shifting to safer assets like government securities, gold, etc.

4. Inflation

Inflation can eat into your returns significantly. A good asset allocation strategy should aim to counter inflation while not exposing the individual to extreme risk. Historically, equity and metals like gold due to their return generating capacity, are given more importance to counter inflation in a portfolio. However, the financial advisor must keep an investor’s risk tolerance in mind before investing their money. For example, gold could be a better investment choice than equity to counter inflation for an extremely risk-averse person. But if the individual has a higher risk tolerance, equity can also be chosen.

Asset allocation strategies will need to be adjusted to inflation rates to maximize returns. If inflation rates are high, equities can be a good option to generate inflation-beating returns. Bonds would not be the first preference in this scenario.  

5. Income and the prevalent tax rates

Your current income level and the tax rates can significantly influence your portfolio. Higher income may attract higher taxes on capital gains taking into account your present taxable income. Even bonds are taxed in line with your income level, except for income from interest and bonds that are exempt from tax. 

Now it is considered a safe bet that tax rates are going to increase in the future. Any asset allocation strategy may fail if your income levels and future tax implications are not taken into account.

How to determine the most viable asset allocation strategy

Warren Buffett, one of the most celebrated and crafty investors, gave a 90/10 rule where 90% of a person’s portfolio would remain invested in low-cost S&P index funds and the remaining 10% in short-term bond funds.

There is another rule – 80/20/12 that represents 80% exposure to equities and the rest to gold. Here, 12 refers to investing your savings in a liquid fund that can be viable for at least 12 months worth of your consumption pattern.

Have you noticed how exposure to various assets keeps changing and shifting dynamics? It is precisely for this reason that asset allocation and exposure may vary from person to person and may not remain constrained to the following numbers – 60/70/80. Warren Buffett, even in his 70s/80s can afford to have a 90% exposure to equities, but this may not be a viable strategy for many individuals.

Some investors may want to have 50/50 exposure to equity and bonds. Some investors may be approaching retirement and may want to invest the majority of his portfolio in bonds. Additionally, individuals may want to hold liquid cash and invest in metals, in any combination of numbers that suits them best.

Analysts and investors have been able to determine a rough combination of numbers after years of research and analysis, each specific to an age group. You may find these suggested numbers in the table below.

Asset allocation by age

Age group Stocks/equities and related instruments Bonds, G-securities and more Cash, gold, money market instrument and more
20s/30s 90-100%0-10%
40’s80-100%0-20%
50’s65-85%15-35%
60’s45-60%30-50%0-10%
70’s30-60%40-60%0-20%

Do you observe how as more time passes, equity exposure is reduced with bonds and how important age as a factor is in asset allocation besides risk tolerance?

An individual may follow any rule as per his/her understanding. But one needs to be aware of the changing market dynamics of different investment instruments to gain the maximum amount of benefit.

To summarize

Asset allocation can be a little tricky due to a plethora of options available to you, ranging from stocks to bonds to gold and others. However, if you deploy asset allocations strategies such as the 70/30 and 60/40 rule, you can effectively mitigate your risk while maximizing your returns. However, before doing so, you need to consider your age and risk tolerance before committing to any instrument or rule. Consult your financial advisor before settling on a particular strategy.

Use the free advisor match tool to match with an experienced and certified financial advisor who will be able to guide you effectively on the pros and cons of different asset allocation strategies and suggest a suitable one based on your risk tolerance and future financial goals Give us basic details about yourself, and Paladin Registry will match you with 1-3 professional financial fiduciaries that may be suited to help you.

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