Equity-debt split: How age and risk tolerance should guide your allocation

Stocks versus debt allocation

The following approach is designed to align risk tolerance with an investor's changing financial needs and risk capacity as they grow older.

The formula is:

• Percentage in stocks = 100 - your age
• Percentage in bonds = your age

For example, if you're 40 years old, this rule suggests allocating 60 percent to stocks and the rest 40 percent to bonds such as debt funds or fixed-income instruments. This formula suggests that as you age, you should gradually decrease the proportion of stocks, which are more volatile, and increase bonds, which are more stable.

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This approach works under the assumption that younger investors have more time to recover from market declines, while older investors prioritise stability as they approach retirement.

Although not a rule, younger investors may have fewer responsibilities towards their families, which might free them up for more risky investments like stocks.

Also, keep in mind that your Employee Provident Fund (EPF), Voluntary Provident Fund (VPF) and fixed deposits (FDs) also come under debt allocation.

Aggressive early, conservative later

Investors in their 20s, 30s, and even 40s have a longer time horizon before they need to access their funds, allowing them to take on more risk. This often results in a higher allocation of assets in stocks. As you grow older and are in your 40s and 50s, start moderating risk by increasing bond allocation. This helps protect against market downturns while still allowing for growth through stock investments.

For investors near retirement, it is better to shift focus toward bonds or other low-risk assets to preserve capital and ensure stability.

However, older investors with a steady stream of income, ample emergency corpus and sufficient insurance can still look at higher equity allocation.

Factors beyond age

While age plays a key role in asset allocation, it shouldn't be the sole criterion. Other factors should also be considered when determining your asset allocation.

Your investment time horizon is an important factor in determining asset allocation. For short-term goals, a more conservative approach such as investing in bonds and cash is usually advised to protect capital. In contrast, long-term goals can support more aggressive allocations toward stocks.

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Also, your asset allocation also depends on your comfort level with market volatility. While stocks can be volatile in the short term, they often deliver higher potential returns over the long run. In contrast, bonds and cash are more stable but typically give lower returns. Along with volatility comes the ability to absorb losses. Are you comfortable with a short-term loss, or a market downturn can significantly affect your financial stability?

Keep these aspects in mind while allocating to different assets.

Although age serves as a valuable guideline for asset allocation, it should be considered alongside your unique financial situation, objectives, and risk tolerance. Relying exclusively on age may result in a disconnect between your needs and how your portfolio performs.

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