Ideal Asset Allocation in Retirement: 60/40 vs. 70/30 (2024)

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 ofinvesting is asset diversification. It is unwise to have just one kind of assetin your portfolio as it makes you vulnerable to risk, should the market undergoa period of volatility. Hence, diversification is necessary, as it not onlyhelps 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 extensiveanalysis and experiments, financial analysts have come up with certain rulesand strategies concerning asset allocation that hold true for people havingsimilar financial conditions and risk profiles. While it is always consideredsuitable to get your personal situations analyzed by a financial advisor whenmaking investment decisions, the basic starting point or benchmark for assetallocation has come to be designed around certain rules.

Usually, a combination orexposure 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 30and 40 represent exposure to bonds. These numbers are read together to give anindividual the approximate percentage of exposure they should have to stocksand bonds, respectively.

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

1. Stocks and bonds are consideredas ‘traditional assets’ and it is quite possible to create an entire portfoliocomprising of just these two assets.
2. Stocks and bonds are markedlydifferent from each other in various respects such as risk exposure, theirfunctioning, as well as return generation capacity. In fact, they share aninverse relationship. When stocks go down, bonds tend to do well, andvice-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 allocationstrategy wherein an individual shall have 70% stock exposure in theirportfolio. The remaining 30% may be allocated to bonds. Now, it is well knownthat equities are a risky asset class. On the other hand, bonds have historicallybeen safer with stable returns. Given equities have a higher allocation in the 70/30 rule, this strategymay be more suited to individuals whohave a higher risk appetite. That said, financial advisors generally tend tosuggest including a little equity in every portfolio to capitalize on itspotential as a wealth multiplier.

Within this 70%, an individualmay either pick direct equities, equity mutual funds, ETFs or any other equityand equity related products. They may choose the most aggressively growingstocks or a high dividend yielding stock. But if the individual is close toretirement, a combination of more stable equity such as large-cap stocks,blue-chip stocks, mutual funds or index funds may be safer options for thiskind 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 isgenerally governed by various factors including demographics and economics, the70/30 rule may serve as a good starting point for most investors. Investors whohave higher risk tolerance and are in their 20s/30s can benefit from the 70/30 rule. Returns fromequities can compound themselves over time, giving good returns right beforeretirement. You may use this rule as a starting point and change thepercentages as per your discretion.

What is the 60/40 rule?

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

Investors in their 40’s/50’swith a moderate risk profile may find this strategy to be more viable. Thesefolks are closer to retirement, hence,they may prefer to focus on capital preservation over wealthaccumulation 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 strategiesprimarily aim for risk dilution and profit maximization, you, as an investor,need to understand that these strategies are heavily influenced by variousfactors and circ*mstances.

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

1. Risk

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

If you are somebody who ishighly risk-averse, even a 60/40 asset allocation may not be suitable. Here, acombination of 80% to 90% to bonds and other government securities may be moreviable. This means that your assets will have 80% allocation or exposure tosafer securities and the rest in equities. On the other hand, if you have agood 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 guideasset allocation strategies for most, it is age that guides risk.

A young adult in his 20s or 30smay have higher risk tolerance compared to someone who is in their 50s or 60sand fast approaching retirement. This is because young individuals have time ontheir side and can stay invested for a longer period of time or work towardsbuilding an alternative income for themselves. You can take a more riskierapproach when it comes to investment and invest your money in assets likestocks, precious metals, real estate, cryptocurrency, etc. Here, an asset allocationwith 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 largelyunpredictable. Very few investors could predict the dot-com crisis, the housing bubble crash, or the Covid-19pandemic. Consider a grim scenario where you had planned to retire during suchturbulent times. You may suddenly find out to your horror that your investmentshave bottomed out and your losses are sky-high, with bonds being the onlycounter, 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 yourreturns significantly. A good asset allocation strategy should aim to counterinflation while not exposing the individual to extreme risk. Historically,equity and metals like gold due to their return generating capacity, are givenmore importance to counter inflation in a portfolio. However, the financialadvisor must keep an investor’s risk tolerance in mind before investing theirmoney. For example, gold could be a better investment choice than equity tocounter inflation for an extremely risk-averse person. But if the individualhas 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 andthe tax rates can significantly influence your portfolio. Higher income mayattract higher taxes on capital gains taking into account your present taxableincome. Even bonds are taxed in line with your income level, except for incomefrom 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 tovarious assets keeps changing and shifting dynamics? It is precisely for thisreason that asset allocation and exposure may vary from person to person andmay 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 maynot be a viable strategy for many individuals.

Some investors may want to have50/50 exposure to equity and bonds. Some investors may be approachingretirement and may want to invest the majority of his portfolio in bonds.Additionally, individuals may want to hold liquid cash and invest in metals, inany 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

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

An individual may follow anyrule as per his/her understanding. But one needs to be aware of the changingmarket dynamics of different investment instruments to gain the maximum amountof benefit.

To summarize

Asset allocation can be a littletricky due to a plethora of options available to you, ranging from stocks tobonds to gold and others. However, if you deploy asset allocations strategiessuch as the 70/30 and 60/40 rule, you can effectively mitigate your risk whilemaximizing your returns. However, before doing so, you need to consider yourage and risk tolerance before committing to any instrument or rule. Consultyour 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.