10.4.5. Asset Allocation
On the exam, you may see questions that ask you for a suitable allocation of assets for a given customer. While these questions can seem somewhat subjective, there are rules of thumb that can help to navigate these kinds of questions. The first rule of thumb, is sometimes referred to as the 100 rule. Generally, a suitable portfolio is one in which the percentage of equity securities is close to 100 minus the customer’s age. For instance, a 40-year-old customer’s portfolio should be made up of roughly 60% equity securities. Much of the remainder of the assets would be fixed-income investments, such as bonds, as well as a smaller percentage of cash. This asset allocation breakdown is often referred to as a standard asset allocation.
Of course, there are other factors, which were discussed previously, that should be considered when determining asset allocation. These include, but are not limited to, risk tolerance, investment objectives, tax consideration, and liquidity needs.
Example: Jennifer is a 35-year-old investor. Under a standard asset allocation model, a suitable portfolio for her would contain 65% equities. The remaining 35% of the portfolio would contain mostly fixed-income securities and a smaller percentage of cash.
Let’s look at a few hypothetical customers and suitable asset allocation percentages for their portfolios:
Example: Jim and Joan are both in their early 40s. They are in a high tax bracket and are saving for retirement. They also have a moderate risk tolerance. A suitable portfolio for them might contain 60% stocks and a mix of 40% bonds and cash.
Based on the standard asset allocation model, Jim and Joan should have a portfolio that contains more stocks than bonds, but the split between the two investment types should not be great. Since they are saving for retirement, they would be considered growth investors, so having more equities than fixed-income se