planning risk

The Most Important Key to Investing Success

Do you know what separates the great investors from the lousy ones?  Do the greats just have a knack for picking winning stocks?  Do they have access to information that mere mortal investors don’t?

Actually, the key to investing success is much more boring sounding.  It’s making sure you choose the right asset allocation.

What in the world is that?  It’s how you spread your investment dollars across various types of investments.  For example, if you have $1,000 to invest, knowing whether to put 60 percent of it into stocks and 40 percent into bonds or 80 percent into stocks and 20 percent into bonds is asset allocation.

Research has shown that choosing the right asset allocation is even more important to your investing success than which specific investments you choose.

What’s the Right Asset Allocation for You?

You’ll find some free asset allocation calculators on the Internet, but one of my favorite tools is even simpler to use.  It’s the Lifetime Allocation Indexes (scroll down to “Investing” and click on “Asset Allocation Guidelines from Morningstar”) provided by the investment research organization, Morningstar.

To use this tool, your first step is to find the “Assumed Investor Age” closest to your current age.  The asset allocation recommendations are based on an assumed retirement age of 65.  If you’re building an investment plan around a different retirement age, choose a different “Assumed Investor Age.”  If you’re basing your plan on a retirement age of 70, for example, choose an “Assumed Investor Age” that’s about five years younger than your current age.

Next you’ll have to choose among Morningstar’s aggressive, moderate, or conservative allocations.  Pick the one that seems to fit with your temperament.

Age and Investment Risk

Even with its moderate and conservative asset allocation recommendations, you’ll see that Morningstar recommends a pretty aggressive investment mix for young people – mostly stocks, a bit of bonds, and some inflation hedge-type investments. It’s a standard bit of thinking in the investment world that the younger you are the more risk you can afford to take.

A 60-year-old wouldn’t want such an aggressive asset allocation because she doesn’t have the time to ride out the stock market’s ups and downs.  She’s going to want a much more conservative mix.

How to Keep Investing Simple

Okay, so now you know how your money should be spread among different types of investments, which puts you way ahead of most people.  But now you have to pick the actual investments that reflect the recommended asset allocation.  Whether you choose individual stocks or mutual funds, there are lots of possibilities.

There are two ways simplify this process, which is what I’ll cover in the next post.  For now, I just want you to understand the importance of asset allocation and to have a sense as to the right allocation for you.

How intentional have you been in choosing investments based on an appropriate asset allocation for someone your age?

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One Response to The Most Important Key to Investing Success

  1. Broad Financial July 11, 2011 at 3:31 PM #

    This is a great read Matt! Giving people an overview and tips on smart investment is just absolutely vital. Great work man!

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