A good net worth allocation is important to weather the consistent financial storms that seem to come every 5-10 years. The last thing you want is to have a net worth allocation mismatch with your risk tolerance and objectives.
To start, the median 401(k) is hovering only around $100,000. The average 401(k) balance at retirement age 60 is only around $230,000. Therefore, many Americans will have a difficult time retiring comfortably. Let’s not even talk about those Americans without a tax-advantageous retirement plan.
Just do the math yourself. Add the average Social Security payment per person of ~$18,000 a year to a 4% withdrawal rate on $230,000. You get $27,200 a year to live happily ever after until you die. We need to do more to boost our wealth.
Can you imagine spending almost 40 years of your life working just to live off minimum wage in retirement? At least, hopefully, you were able to live it up during your working years.
Blowing lots of money is OK if you expect to live with financial uncertainty every day when you’re old. However, the better way to do things is to smooth out your spending across your expected life expectancy. This way, you can reduce stress and live a much steadier lifestyle.
Recommended Net Worth Allocation By Age
We’ve talked in detail about the proper asset allocation of stocks and bonds by age. If you had 100% of your investment allocation in stocks before 2008-2009, and wanted to retire by 2010, well then you are out of luck. You’ll be forced to work for many more years.
To find out how many more years you would be forced to work, calculate how much you lost. Equate your loss to how many years it took you to save the value of the loss. Now expect to work that many more years of your life.
Know your true risk tolerance with Financial SEER. You must quantify your risk tolerance in terms of potential time lost. After all, time is our most precious commodity.
The Average American Is Not Diversified Enough
Although I love real estate, the average American is either too heavy into real estate or has poor net worth diversification. The lack of diversification is because most of the average American’s net worth is tied up in his or her primary residence.
Let’s take a look at what happened during the last financial crisis. By 2010, the median net worth plunged by 39% to $77,300 from a high of $126,400 in 2007. Meanwhile, the median home equity dropped from $110,000 to $75,000.
In other words, the median American’s net worth consisted almost entirely of home equity. No wonder why Americans were in such great pain between 2008 – 2010.
Take a look at this chart below. It highlights how a record high 30% of American households have no wealth outside their primary residence. That’s not good enough. Building more wealth outside your primary residence is a must.
Anybody who has lived through the 1997 Russian Ruble crisis, the 2000 internet bubble, and 2006 – 2010 housing correction probably has a good portion of their net worth in CDs, bonds, and money markets because they’ve been burned so many times before.
With tremendous uncertainty returning in the new decade, figuring out a proper net worth allocation is more important than ever before.
Figuring Out The Proper Net Worth Allocation
The question we must all ask ourselves is, “What is the right net worth allocation to allow for the most comfortable financial growth?” There is no easy answer to this question as everybody is of different age, intelligence, work ethic, and risk tolerance.
I will attempt to address this question based on what has worked for me so far. I believe these net worth frameworks can help anybody serious about building enduring financial wealth for the long run. You’ve always got to do what works best for you.
I’ve spent over 30 hours writing and revising this post over the years in hopes that every Financial Samurai reader can build a rock steady net worth portfolio. The goal is to make money in good times and lose less money in bad times.
Further, I’m always looking for more input from the community to make the recommended net worth allocation figures better.
Before we look at the charts, let’s go through the mental framework for investing and building wealth.
Mental Framework For The Recommended Net Worth Allocation
1) You are not smarter than the market
I don’t care how much you’ve been able to outperform the stock market over the years with your $10,000 stock trading account. The fact of the matter is your performance will normalize over the medium-to-long run. As you grow your assets to the hundreds of thousands or millions of dollars, you aren’t going to be whipping around your capital as easily as before. Your risk tolerance will change.
The most dangerous person is one who has only experienced a bull market. They think they are invincible, confusing a bull market with their brains until the next inevitable downturn comes and wipes them out.
Get it in your head you will lose money at some point. There is no risk-less investment unless you are putting less than $250,000 in CDs, money markets, or buying US treasuries.
Take a look at the active versus passive equity fund performance yourself. It is shocking how many professional money managers underperform their respective indices. The below chart shows that 81%+ of equity mutual funds underperformed over the past 10 years.
2) You are not a financial professional
Even if you were a financial professional, your investment returns will likely underperform. I’ve been investing since 1995, and still regularly blow myself up. As a result, I’ve followed a net worth asset allocation model to minimize potential damage.
Know your expertise. If you are a software engineer, your expertise is in creating online programs not giving investment advice. If you are a doctor, your expertise may be in giving a patient a catheter, not going all in on real estate syndication.
It would be nice to know the future. If I did, I’d probably be on a mega yacht in the South of France getting a massage right now! The only thing I can do is come up with rational expectations, and invest accordingly. If you can’t come up with a coherent 5-minute presentation to a loved one why you are investing the way you are, you might as well be throwing darts.
3) You only have at most 110 years to live
Statistics say the median life expectancy is around 82-85 years old. Less than 0.1% of the 6 billion people on earth live past 110 years old. As a result, you must plan for roughly 80-90 years of life after secondary school. The good thing is you have a time frame to plan for your financial well being. The bad thing is you might die too early or live too long.
It’s better to plan for a longer retirement and have money left over to give to others than come up short. This is why managing your finances consistently is so important. You need to predict the future, then spend, save, and earn accordingly.
4) Your risk tolerance will change over time.
When you’ve only got $20,000 to your name and you’re 25 years old, your risk tolerance is likely going to be higher than when you have a net worth of $2 million and are five years away from retirement at 60. When you’re young, you naively think you can work at your same job for years. The feeling of invincibility is incredible until something happens.
Do not forget to give yourself a thorough financial assessment at least once a year to make sure your net worth allocation is appropriately dispersed. Ignoring your finances is not the way to financial prosperity. If you gamble with your finances during the latter stages of your life, you will have a much lower chance of recovering.
5) Black swan events happen all the time
Hello global pandemic! A black swan is supposed to be rare, but if you’ve been paying attention for the past couple decades, incredible financial disruption happens all the time.
Nobody knows when the next panic induced correction will incur. When Armageddon arrives, practically everything gets crushed which is not guaranteed by the government. It’s important to always have a portion of your net worth in risk-free assets.
Further, you should consider investing your time and money in things that you can control. If you want evidence of people not knowing what they are talking about, just turn on the TV. Watch stations trot out bullish pundits when the markets are going up and bearish pundits when the markets are going down.
Not many people could have predicted a coronavirus pandemic would shutdown the entire global economy for at least a quarter and cause tens of millions of Americans to lose their jobs. Always be prepared for a black swan event, especially if you’ve already reached financial independence.
6) Bull markets can make you incredibly rich
Not everyone got crushed in the dot com bubble. Plenty of people sold their Webvan stock at the top! The same thing is going on with all this Gamestop mania in 2021.
Bull markets generally last in 5-10-year cycles. The direction is almost always up and to the right over a long enough time period.
It often times feels worse missing out on a huge gain than losing money. We call this investing FOMO. Therefore, it’s important to have at least half of your net worth exposed to a potential bull market. The power of inflation cannot be underestimated. If you are a price taker without inflating assets, you are losing.
The issue with getting rich is that you must take extra risk. Even if the NASDAQ closes up 45% again, like it did in 2020, you aren’t richer if everybody is up 45%. To get rich, you must outperform various financial benchmarks.
Recommended Net Worth Allocation By Age: Base Case
I’m now going to offer up three net worth allocation frameworks to follow. Let’s start with the Base Case recommended net worth allocation. The base case is for those of you who are fine with working for four decades and retiring at a traditional retirement age past 60.
Base Case Assumptions
* All percentages are based off a positive net worth. If you have student loans right out of school, or a negative net worth due to negative equity, use these charts for the asset side of the balance sheet equation. Systematically look to reduce non-mortgage debt as you build your wealth building assets.
* Stocks include individual stocks, index funds, mutual funds, ETFs, structured notes. Bonds include government treasuries, corporate bonds, municipal bonds, high yield bonds, and TIPs.
* For the first eight years of work, the majority of your net worth is in stocks and risk free assets such as CDs, higher yielding online savings accounts, and money market funds.
* By the age of 30, you should have some idea of where you want to live. You should at least know what you want to do for a living. With this confidence, you shift a major portion of your net worth into buying your first home.
* One of your financial goals should be to get neutral real estate as soon as you know where you want to live and what you want to do. The return on rent is always -100%. After 40 years of renting, you have nothing to pass on. Nor do you have a place to live rent free in retirement. As long as the government is subsidizing homeownership, and as long as people don’t have the discipline to save and invest the difference, renting is discouraged if you can afford to own.
* Risk-free assets also start off high given you’ve first got to save money to build a financial foundation. It’s not wise to dump all your savings in the stock market if you don’t know what you’re doing. Gradually leg in the more comfortable you become with investing. Stocks have proven to be the most straightforward way to grow one’s net worth over the long run. You’re also not that interested in bonds because your risk tolerance is high and interest rates are so low. The Risk Free column can also be called the “Emergency Fund” column if you like.
* If you just don’t want to own property, then you should consider gaining real estate exposure through REITs or real estate crowdfunding. Real estate crowdfunding allows you to invest in cheaper, higher yielding real estate across America.
* Alternative investments stay at 0%. It’s already hard enough to get people to save more than 20% of their income and buy a house. To then ask to invest in stocks and buy alternative investments may be too much.
* The ultimate goal is to have a roughly equal balance mix between stocks, bonds, and real estate. Have a 10% risk free buffer in case the world comes to an end. In a difficult economic environment, stocks and real estate will decline (60% of net worth). However, at least 30% of your net worth (bonds) will increase, while your 10% emergency fund remains intact.
Recommended Net Worth Allocation: New Life
The New Life framework changes things up after around 40. By the time you’ve graduated high school, you’ve already experienced the normal way of living. You now want to experience a “new life” in the second half.
The New Life Framework essentially investments in more alternative assets like venture capital, private equity, and building your own business.
New Life Assumptions
* After five years of savings, you purchase your first property and reduce your Risk-Free percentage down to 10% from 30%. If you own the property you live in, you are neutral real estate. The only way you can make money in real estate is if you buy more than one property. If you are a renter, you are short real estate.
* After 13 years of saving and investing, your net worth increases handsomely. The decline in stocks as a percentage of net worth doesn’t mean a decline in the value of your stock portfolio. Rather, due to the increase in your overall net worth, the absolute value of your stock portion increases despite a decrease in the percentage of total.
* With a larger net worth, you invest some of your savings into Alternative asset classes by age 35. Alternative asset classes may include: private equity, venture capital / angel investing, or starting your own company. You’ve got stocks, bonds, and real estate down pat. With free liquidity, you dable into the unknown because you never want to look back and say, “what if.”
* After the age of 40, you’re looking for a more balanced mix in your net worth. As a result, you purposefully invest less in stocks and more into bonds and alternative investments. Your real estate equity also holds steady, market willing.
* Starting around age 40, you’re also wondering what else is there to life. You’re getting burned out doing the same old thing for almost 20 years. Maybe you negotiate a severance to start your own business. Maybe you just take a long sabbatical to do something new. You are anxious to start a new, more exciting life with the only one you’ve got.
* By the time you’re 60, you have a wonderful net worth balance that is practically implosion proof. Your Risk-Free percentage increases along with your Bond percentage. You enjoy the feeling of stability and security as you plan to live until 110 years old.
Recommended Net Worth Allocation: Self-Belief
The Self-Belief framework is one where you bet more on yourself. You believe the traditional way of building wealth is getting outdated. However, you still diligently build your financial foundation in your 20s. The 20s is when you’re learning so that you can really start earning in your 30s and beyond.
The Self-Belief net worth allocation framework incorporates the X Factor. The X Factor is going all-in on building a business for greater wealth. After all, the wealthiest people in the world are all entrepreneurs.
* The Self-Belief framework assumes you have better control your own financial future than other investments. When you invest in stocks, bonds, and real estate, you are depending on someone else and favorable macro conditions to make you money. When you invest in You, you believe you have a superior ability to build wealth.
* The Alternative column’s name changes to the X Factor. The X Factor assumes you finally start your own business or side venture. It is your X Factor which could really boost your wealth.
* You don’t have to own real estate in the Self-Belief framework given you’d rather use the downpayment capital on your own business. Feel free to increase the X Factor column percentage by the Real Estate column percentage if this better fits your goals.
* After decades of building your X Factor, you take some risk off the table. You increase your Risk-Free percentage. By this time, your net worth has grown large enough where you can live off returns as low as 2-4%.
* If you are wildly successful in building your own business, the X Factor column can easily dwarf all other columns. See the below chart from my post, Net Worth Composition By Levels Of Wealth. Notice how the X Factor, the dark blue portion grows as one gets wealthier.
The Proper Net Worth Is Well Diversified
Financial returns are not guaranteed. As a result, it’s best to keep a diversified net worth mix that can withstand the hits of severe economic downturns, while benefitting from multi-year bull runs.
You are free to follow my recommended net worth allocation guide closely or not at all. Only you know your financial objectives and your ability to withstand shocks the best.
When it comes to building wealth, I encourage everyone to focus on a realistic worst case scenario where all assets except for the risk-free portion tanks by 30% – 50%. This way, you’ve addressed your biggest fears so you can move on with your quest.
Imagining a best case scenario is fine as it’s always good to dream. There just has to be a balance with your wealth building approach as to not come up short when you can no longer work.
I’m confident that if you follow any one of these net worth allocation frameworks, you will achieve an above average net worth over time.
Remember, the average American has ~90% of their ~$100,000 net worth in their primary residence. This is dangerous. It means the average American i not actively investing in other asset classes. I would limit real estate to no more than 50% of your net worth and ideally 35% of your net worth.
Perhaps my recommended net worth allocation guides are too conservative. Or maybe they are too aggressive. Whatever your beliefs, you must at least come up with your own net worth allocation framework to follow throughout your life. Just remember to enjoy the journey along the way.
Recommended Net Worth Allocation Tool
The easiest way to monitor your net worth allocation is with Personal Capital. It is a free online tool that lets you not only track your net worth allocation, but track your cash flow, and investment as well.
My favorite feature is the Retirement Planning Calculator that let’s you forecast your future cash flow. If your forecast is light, you can make adjustments well in advance. Don’t gamble with your financial future.
I’ve used Personal Capital to track my net worth since 2012. It’s the best free tool on the web.
Build Wealth Through Real Estate
Real estate is a core asset class that has proven to build long-term wealth for Americans. Real estate is a tangible asset that provides utility and a steady stream of income if you own rental properties.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
All my recommended net worth allocation frameworks have real estate. If you rent, you are short real estate. That’s no good for the long-run, just like shorting the S&P 500 is no good for the long run.
Take a look at my favorite two real estate crowdfunding platforms for real estate investing.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eREITs. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT for real estate exposure is the beset way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot of capital, you can build your own select real estate portfolio with CrowdStreet.
Both platforms are free to sign up and explore.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.