While it is important to have money in the stock market, as that is where you can really grow your net worth, it is really important to have that money working correctly for you.
As you have learned in some of our other blog posts about investing, there are many different ways you can invest your money in the stock market, from stocks to bonds to real estate to commodities to cryptocurrency.
The percentage of each of these items inside your accounts matters greatly, especially given when you plan to use the money you have in your investment accounts. Below is a general breakdown of how we suggest adjusting the percentages of your different investments, aka how to determine your ideal asset allocation:
– Immediate need (1-2 years) = 100% cash
– Short-term allocation (3-4 years) = 60% stocks and 40% bonds
– Medium-term allocation (5-9 years) = 75% stocks and 25% bonds
– Long-term allocation (+10 years) = 90% stocks and 10% bonds
To give an example of how this would work, let’s take a retirement account. You add $6,000 annually to the account for 45 years:
$6,000 annually x 45 years = $270,000
Now let’s say that you invest that money conservatively, so it’s only growing at about 3% annually. That would give you roughly the following amount come retirement:
$6,000 annually x 45 years x 3% annual rate of return = $555,000
If you however set your asset allocation correctly, so the 90% stocks and 10% bonds mix above, then the average growth rate annually is 7%. That would give you roughly the following at retirement:
$6,000 annually x 45 years x 7% annual rate of return = $1,710,000
See the importance of a correct asset allocation then? It’s not enough to just put your money into an investment account and/or retirement account. You have to set the parameters (i.e. asset allocation) correctly so that it works best for you.
The same is true if you need the funds sooner rather than later: you won’t want to set the account too aggressively with your asset allocation. The stock market is constantly moving up and down and there are going to be recessions over the cycle of your investing life cycle; it’s just the way the economy works. So if you need the funds sooner rather than later and you are invested aggressively, then the risk is even higher that the stock market will be down when you need to pull the funds out of your investment account and you could lose money.
If you need to make any changes to your asset allocation, it is something easily done inside your account. If you have a robo advising account, then you would change the percentage of stocks versus bonds in the account. If you have an investment account that is not a robo advisor, you will have to make the changes manually. Do keep in mind though, that any changes to your investments may trigger a capital gain. That depends on various factors, but it is something to keep in mind.
How to Know if You’re Investing Your Money Correctly is written by Jenny Harp, A Certified Financial Trainer for financialgym.com