60/40 vs 70/30 Asset Allocation: Which Is Better For Retirement?

For effective and successful financial planning, one must select the right composition of asset classes based on your risk tolerance, investment horizon, financial needs and goals. This is known as asset allocation. It refers to an investment strategy wherein the objective is to balance risk and reward through the allocation of assets as per an individual’s risk appetite and short and long-term financial goals. There are primarily three main asset classes namely, equities, fixed-income, and cash and equivalents.

There are a number of popular and time-tested asset allocation strategies such as the 70/30 rule and the 60/40 rule that you can try to effectively manage your risk/exposure levels and find the right combination that suits your needs. If you wish to learn more about different asset allocation strategies and how to diversify your risk, reach out to a professional financial advisor who can advise you on the same.

Herein, we will discuss the aforesaid asset allocation strategies along with the different factors that you should consider before selecting a particular strategy to reach your retirement goals.

What is meant by asset allocation?

Asset allocation means the creation of an investment portfolio based on an individual’s risk profile and investment goals. Herein, the selection of individual securities is secondary compared to which asset class you are investing your money in. Diversification is extremely important and care should be taken that you are not exposed to just one kind of asset class to minimize risk. Doing so not only mitigates risk but also helps generate higher returns. So, you can diversify your risk by investing in different kinds of asset classes such as stocks, bonds, commodities, cash and cash equivalents, real estate, and more.

In the 70/30 or 60/40 rule, the numbers represent the combination or exposure percentage to stocks and bonds. Herein, the numbers 70 and 60 represent exposure to stocks while 30 and 40 describe exposure to bonds. If you are wondering why only stocks and bonds are being used to determine the asset allocation mix, it is due to two reasons:

1. Stocks and bonds are considered ‘traditional assets’ and if one wants to, they can create their entire portfolio composed of just stocks and bonds.
2. Stocks and bonds differ on a number of parameters such as exposure to risk, and functioning, as well as the capacity to generate returns. They also share an inverse relationship wherein if the value of stocks falls, the value of bonds tends to rise, and vice-versa.

Let us understand the 70/30 rule and the 60/40 rule in detail.

What is meant by the 70/30 rule?

The 70/30 rule refers to an asset allocation strategy wherein an individual’s portfolio may be composed of 70% stocks and 30% bonds. The aim here is to balance the equity risk with the comparatively stable returns provided by bonds. This strategy is more suitable for folks who have higher risk tolerance. Typically, financial experts advise including some equity in every portfolio to benefit from its potential as a wealth multiplier.

If we talk about the breakdown of 70%, you may include direct equities, equity mutual funds, ETFs, or any other equity and equity-related products in your portfolio. You may focus on investing aggressively in stocks that pay out high dividends. However, as you near retirement, you may need to reshuffle your strategy and pick safer equity options such as stocks belonging to large-cap or blue-chip companies, mutual funds, or index funds. Here, 30% exposure to bonds helps you to minimize your risk to a certain extent and also provides stable returns.

The 70/30 rule may suit younger investors (those in their 20s and 30s) having a higher risk appetite. They can harness the power of compounding to allow their funds to grow over time and build a substantial retirement corpus. This can serve as a good starting point allowing you to make changes later down the line, should you choose to do so.

What is meant by the 60/40 rule?

Similar to the 70/30 rule, in the 60/40 rule, your exposure to equities stands at 60% and to bonds at 40%. This rule is suitable for more conservative investors who give greater importance to stability. This strategy is considered viable for investors (those in their 40s and early 50s) having a moderate risk profile. From this moment onwards investors tend to lean towards capital preservation over capital appreciation.

Since both 70/30 and 60/40 strategies have more than 50% exposure to equities, are these rules suitable for those investors who are fast approaching retirement? Let us find out.

What factors to consider when selecting an asset allocation strategy?

Every asset allocation strategy aims to balance risk with reward. They may differ in the combination of securities used by them but the underlying principle remains the same: to generate maximum returns with minimum exposure to risk. There are certain factors that you should consider when choosing a strategy that matches your needs. The factors are as follows:

1. Be aware of your risk tolerance

Risk is one of the primary factors taken into account when designing an investment strategy. Based on your risk appetite, your advisor would suggest certain strategies such as 70/30, 60/40, etc. If you have a low-risk tolerance, in that case, even a 60/40 strategy may not be ideal for you. Herein, the advisor can suggest investing a higher percentage of funds (such as 80 to 90%) into bonds and government securities keeping in line with your risk profile. However, if you have a high-risk tolerance, you would prefer having a higher allocation of funds in stocks and other equities. Your level of risk tolerance plays a critical role in guiding your asset allocation strategy.

2. Consider your age and life stage

As stated above, risk plays an important role in forming your asset allocation strategy, however, it is age that guides risk. When you are on the younger side (in your 20s or 30s), you may have higher risk tolerance. You are more likely to take risks compared to someone who is in their early 50s or nearing retirement age. This may be primarily due to having more time to recoup your investment if you have made some bad investments. You have time on your side and thus, may be able to take bigger risks. On the other hand, individuals who are in their 50s and 60s, tend to become more conservative and look to preserve their capital as they may not wish to jeopardize their savings and ruin decades worth of financial planning. Thus, age plays a critical role when it comes to determining your exposure.

3. Tackling market volatility

Markets tend to be largely unpredictable and volatile to changes happening around the world. Be it the current Russia-Ukraine conflict that has sent commodity prices soaring and an uptick in the inflation rate or the COVID-19 pandemic, it is advised that you remain prepared for any unforeseen market uncertainties.

To ride out these tumultuous times, your asset allocation strategy should focus more on picking safer assets such as government securities, gold, etc. that will offer stability and serve as a shield against incurring huge losses.

4. Create an investment strategy that offsets inflation

If left unchecked, inflation can cause a serious dent in your finances. It can chip away at your returns while slowly eroding the value of the dollar over time. An ideal asset allocation strategy looks to counter inflation without exposing the investor to extreme risk. To create an inflation-beating portfolio, your advisor can recommend investing in equities and gold. However, the advisor must keep his client’s risk tolerance in mind while devising such a strategy. For instance, gold could serve as a better option for a risk-averse investor, however, someone having a higher risk appetite may choose to go with equities to counter the effects of inflation. With that said, you would need to adjust your asset allocation strategy as per the prevalent inflation rate to maximize your returns. Here, going with stocks would be a better choice rather than bonds to generate higher returns.

5. Don’t neglect to consider the effect of taxation

If you fall in a higher tax bracket, you would have to take certain measures to minimize your taxes. High-income earners attract higher capital gains taxes and you may need to deploy tax-saving strategies to keep your tax bill at a minimum. As tax rates are expected to grow in the future, it would be wise to create an asset allocation strategy that focuses on the effect of tax implications on your investment portfolio.

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What is the most viable asset allocation rule?

One of the most noteworthy Wall Street icons, Mr. Warren Buffet, devised a 90/10 rule wherein an investor would invest 90% of their funds in low-cost S&P index funds and 10% in short-term bond funds.

The 80/20/12 rule states an investor should keep 80% of their funds invested in equities and the remaining 20% in gold. The number 12 here signifies 12 months or a year meaning you should invest your savings in a liquid fund. With that said, each individual is unique and has a different threshold for risk tolerance. What may work for you, may not work for another. Mr. Buffet can afford to have an 85 to 90% exposure to equities even in his 70s or 80s which may not be a viable option for you. There are several other ways that you can go such as having a 50/50 exposure to equity and bonds, having a portfolio composed of liquid cash and metals, or a bond-heavy portfolio if you are nearing your retirement years.

If you are feeling unsure in which direction to go, you can always consult with a professional financial advisor who may advise you on suitable investments as per your risk tolerance and goals. You can also go through the following table that depicts an approximate combination of numbers specific to an age group for determining asset allocation numbers.

Asset allocation by age

Before you follow any rule blindly, take care to do your own research or consult with a financial expert who can help you come up with a suitable strategy.

To conclude

Asset allocation can be a tricky strategy to execute due to the availability of a wide range of investment options to choose from. However, you can follow widely used strategies such as the 70/30 and 60/40 rules to effectively mitigate risk while maximizing your returns. However, before you commit to a strategy, you need to factor in your age and risk tolerance.

Reach out to a professional who can suggest suitable asset allocation strategies based on your age, risk profile, and future financial goals and needs. Use the free advisor match service and get matched with 1-3 vetted financial advisors that can help you with your unique financial needs and goals.