Goal-oriented Money Management
- Asset allocation is a crucial yet often oversimplified aspect of personal finance. Many younger investors are encouraged to take on more risk for the potential of greater returns, typically resulting in a higher stock-to-bond ratio in their portfolios. Popular methods like the "120-age formula" offer a starting point, but they don't account for individual financial priorities or risk capacity.
In my late 20s, I followed this rule and adopted a 90:10 stock-to-bond ratio, aiming for an aggressive stance towards retirement savings. However, I soon realized that this approach neglected other important goals with shorter time horizons, such as paying off student loans and building an emergency fund. This misalignment led to a more conservative, but more appropriate overall asset allocation than intended. Through this experience, I learned that a rigid formula-based strategy is insufficient. Instead, a goal-oriented approach to asset allocation can better address diverse financial objectives.
How Do I Decide My Asset Allocation?
I start by listing my goals and their time horizons. For example, my goals might include paying off my student loans by the end of next year, putting a down payment on a house in three years, retiring at the age of 62, and sending children to college in 20 years.Next, I categorize these goals as short-term or long-term. I consider goals with deadlines of less than five years to be short-term, while long-term goals are those with deadlines beyond ten years.
Short-Term Goals
For short-term goals, I determine my risk capacity. Can I afford a shortfall when the deadline approaches? If the answer is no, then I have a low-risk capacity and would typically opt for investments that prioritize the safety of principal and liquidity over the high returns of the stock market. Examples of such investments include high-yield savings accounts, money market funds, or U.S. T-bills with maturity dates aligned with my deadlines (though T-bills may not be appropriate for an emergency fund).
For instance, if I'm saving for an emergency fund, I'll choose a high-yield savings account or money market fund. Volatile instruments like stocks can lose value by the time you need the money for a short-term goal. However, if you’re saving for a less critical goal, like a dream car, and can afford to delay the purchase, you might have a higher risk capacity and can consider including some stocks in your investment mix.
Medium-Term Goals
For goals with a time horizon of 5-10 years, I adopt a more balanced asset allocation, typically a mix of stocks and bonds/cash. This approach allows me to tolerate some market dips in exchange for higher returns while still maintaining a degree of conservatism.
Long-Term Goals
For long-term goals, such as retirement and college funds, I invest aggressively because I don’t need the money immediately. My risk capacity and risk tolerance allow me to accept market volatility in exchange for the potential for higher returns over the long term. Sudden drops in the market are manageable since I won’t need the money right away, and I expect that over ten or more years, the overall return will be greater.
- Example Allocation Plan :
Short Term Goals:
How Do I Organize This?
I separate my goals into different accounts. For example, Ally Bank's bucket feature allows me to segregate savings for specific goals like "House," "Emergency Fund," and "Quarterly Tax." For goals managed in my brokerage account, I use different investment vehicles designated for each goal. My "T-bills" are allocated for the student loan lump-sum payment, while various money market funds are earmarked for other short-term goals. Recurring payments, such as rent and subscriptions, come from my checking account and are not separated.
Long-term investing goals are easier to manage because they utilize specific accounts like 401(k)s, cash-balance plans, and 529 plans. I treat each long-term goal separately and don't combine them into a single asset allocation. It’s important to remember that long-term goals will eventually become short-term, necessitating rebalancing.
So, What Is My Overall Asset Allocation?
My overall asset allocation is less aggressive than I initially thought. I don't focus on a single asset allocation across all my portfolios. Instead, I ensure that the investment strategies are appropriate for each specific goal. This approach underscores the importance of personal finance being truly personal and not reliant on a simplified formula based on age.
At Modoo Strategy LLC, we engage in detailed discussions about your financial goals and tailor asset allocation strategies specifically to your needs. We delve into which investments align best with your objectives, providing clarity and guidance throughout your financial planning journey. We understand that financial planning is deeply personal, and we're here to support you in making informed decisions that reflect your unique circumstances.
