Question

what is an appropriate asset allocation for the investment portfolio of a 30 year old? what is dollar cost averaging and what should the investor do to take advantage of it? As the investor gets old, should he/she make adjustments to the allocation? If so, please discuss how the allocation in each asset class should change and why.

Answer 1

A 30-year old has a very long time horizion. Hence, they have above average ability to take risk. This is because they are not dependent on investment income for their daily needs, and they have a long time horizion in which their investments can be compounded to build a sizeable corpus. Therfore, the investment portfolio should have a higher proportion of stocks (which have higher risk but higher returns) and a lower proportion of bonds.

As a thumb rule, the appropriate allocation to stocks = 100 - age. In this case, the appropriate asset allocation is 70% stocks and 30% bonds.

Dollar cost averaging is the practice of investing in the marktes in a systematic manner, whereby a fixed amount is invested periodically. This negates timing risk, and averages out the cost of the investment over a long period. To take advantage of this, the investor should identify an appropriate investment asset, and periodically (say weekly, biweekly, or monthly) invest a fixed sum into the asset.

Yes, as the investors ages, they should make adjustments to the allocation. With older age, the ability to take risk is lower because the remaining time horizion is shorter after which the investor will depend on the investment income for their daily needs. Therefore, as the investor ages, a high proportion of the investment portfolio should be allocated to bonds (which have low risk and low returns) and a low proportion to stocks.