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 financial objectives.
The right net worth allocation by age and work experience will boost your chances of living a comfortable retirement life. The key is to stay on track by following a net worth allocation model. Life tends to get complicated as we age. As a result, it’s easy to get off track.
Before we go through the right net worth allocation, it’s important to understand the baseline of American finances.
The Typical American Hasn’t Saved Much
The median 401(k) is hovering only around $110,000. The average 401(k) balance at retirement age 60 is only around $230,000. Therefore, many Americans will have a difficult time retiring comfortably, even with Social Security benefits.
Just do the math yourself. Add the average Social Security payment per person of ~$15,800 a year to a 4% withdrawal rate on $230,000. You get $25,000 a year to live happily ever after until you die.
$25,000 a year is OK if you’ve got your house paid off and no major medical bills. However, you won’t exactly be living it up in retirement. 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? That doesn’t sound too good, especially with inflation continuing to make things more expensive. At least, hopefully, you were able to live it up during your working years.
What Percentage Of Americans Invest In Stocks?
Stocks and real estate are two of the main asset classes that have historically built the most wealth for Americans. Unfortunately, not every American owns stocks and real estate.
According to the Federal Reserve’s latest Survey Of Consumer Finances, only about 53% of all US families own publicly traded stock in some form. Although this percentage is up from 32% in 1989, it’s still not enough. The median stock value held among households in the market was $40,000.
It is a shame that roughly 47% of American households haven’t participated in the largest stock bull market in history. A low stock investing participation rate has ensured the wealth gap between the rich and power has gotten larger.
What Percentage Of Americans Invest In Real Estate?
According to the latest Census Bureau data, in the fourth quarter of 2020, there were an estimated 82.8 million owner-occupied households in the United States.
Roughly 65.8% of households own their homes as of 4Q2020, up from 65.1% a year earlier. The recent homeownership rate peak was in 2004, at 69.2%.
Although a 65.8% homeownership rate is better than a 53% stock ownership rate, that still means roughly 34.2% of American households missed out on the housing boom since 2010.
In fact, it was the housing bust from 2007 – 2010 that led to a decline in homeownership rates. Thousands of homeowners lost their homes through a foreclosure or shortfall.
As a result, there was a steady decline in homeownership rates until 2015, when credit reports for those who had lost their homes finally began to improve again. Note: A foreclosure usually stays on your credit report for seven years.
As a financial freedom seeker, your baseline goal is to own both stocks and real estate over the long run. If you do, you will likely outperform a large percentage of Americans who own neither.
Now the key question is how much should you own of each asset. Let’s discuss further.
Recommended Net Worth Allocation By Age
We’ve talked in detail about the proper asset allocation of stocks and bonds by age. In the post, I discuss three asset allocation models for stocks and bonds to consider:
- Conventional Asset Allocation
- New Life Asset Allocation
- Financial Samurai Asset Allocation
Therefore, to stay consistent, I will also discuss three net worth asset allocation models based on the Conventional, New Life, and Financial Samurai models here as well. Each net worth allocation model will incorporate the corresponding stocks and bonds asset allocation.
Stocks and bonds (public investments) are usually only one portion of your overall net worth. In addition to public investments, the average person should also invest in real estate. After all, owning a home will always be a part of the American dream.
In addition to public investments and real estate, some people may also want to diversify into alternative investments. An alternative investment is a catch-all term for everything other than stocks, bonds, and real estate.
For example, investments in art, music royalties, farmland, commodities, cryptocurrencies, hedge funds, and collectibles are all considered alternative investments.
Finally, some people may want to start a business while working a day job or take a leap of faith altogether. I call this the X-Factor.
With so many black swan events since 2000, more people are trying to diversify their income sources with side hustles or entrepreneurial activities, especially online.
The Average American Is Not Diversified Enough
To come up with recommended net worth allocation models, we also need to first understand the typical net worth composition of the average American.
Although I love real estate and believe the housing market will stay strong for years, the average American is either too heavy into real estate or has a net worth that is poorly diversified. The lack of diversification is because most of the average American’s net worth is tied up in their 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 ($77,300 median net worth vs. $75,000 median home equity).
Put differently, 97% of the median American household’s net worth consisted of their primary residence! Thus, it’s not hard to understand why Americans were in such great pain between 2008 – 2010. With a diversified net worth that included bonds and risk-free assets, the average American would have faired better.
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 the 2006 – 2010 housing crisis probably has a good portion of their net worth in CDs, bonds, and money markets because they’ve been burned so many times before.
Investors who were heavy into stocks before the 32% correction in March 2020 have probably thought more about their stock and bond allocation and overall net worth allocation as well.
Thankfully, most asset classes have recovered and then some. However, that’s not to say another big correction isn’t right around the corner with valuations so high.
If you plan to retire right before a bear market hits, you might find yourself having to work for many more years instead.
Figuring Out The Proper Net Worth Allocation
The question we should 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 ages, intelligence, work ethic, and risk tolerance. Further, luck also plays a huge part in building wealth.
I will attempt to address this question based on what has worked for me and feedback from some of the millions of readers who’ve come to Financial Samurai since the site began in 2009. I believe following one of these three net worth allocation frameworks can help the vast majority of people looking to achieve financial freedom.
I’ve also spent over 40 hours writing and revising this post over the years. The goal is for every Financial Samurai reader to grow their net worth in a risk-appropriate manner. Let us make more money in good times and lose less money in bad times.
Finally, before we look at the charts, let’s go through the mental framework for investing and building wealth. When it comes to investing and growing your net worth, you must think rationally.
Mental Framework For The Recommended Net Worth Allocation
1) You are not smarter than the market
I don’t care by how much you’ve been able to outperform the stock market over the years with your stock trading account. Eventually, your performance will likely normalize over the medium-to-long run. Most professional money managers fail to outperform their respective indices. Don’t be delusional and think you can over the long run.
As you grow your assets to the hundreds of thousands or millions of dollars, you won’t be whipping around your capital as easily as before. Your risk tolerance will likely decline, especially if you have dependents and aging parents to consider.
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, perhaps not so much on real estate syndication. Then again, everything is the wild Wild West nowadays.
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 about why you are investing the way you are, you might as well be throwing darts.
For the typical investor, I recommend no more than 20% of public investment capital go towards buying individual securities. 80% of public investment capital should be invested in passive index funds and ETFs.
3) You only have at most 110 years to live
Statistics show the median life expectancy is around 82-85 years old. Less than 0.1% of the 7.7 billion people on earth will live past 110 years old. As a result, you should 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 wellbeing. The bad thing is you might die too early or live too long. Whatever happens, planning your finances around various life expectancies is smart.
It’s better to plan for a longer retirement and have money left over to give to others than to 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 high. Even if you lose all $20,000, you can gain it back with relative ease. When you are 60 years old with $2 million and only five years away from retirement, your risk tolerance will likely be much lower.
When you’re young, you naively think you can work at your same job for years. The feeling of invincibility is incredible. Your energy is what can help make your first million.
However, the longer you live, the more bad (and good) things tend to happen. Your energy tends to fade and your interests will certainly change. The key is to forecast these changes by preparing well in advance.
Do not be deluded into thinking you will always be a certain way. Review your finances twice a year and assess your goals. Accept that life doesn’t go in a straight line.
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 of 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 that 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 shut down the entire global economy for over a year 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) Take Advantage Of Bull Markets
Bull markets tend to last between 5-10 years. This is the time period when you can get incredibly rich. The goal is to know you are in a bull market and allocate your net worth accordingly. For example, I believe we will be in a housing bull market for years to come. As a result, I’ve invested 40% of my net worth in real estate.
The last thing you want to do is have most of your net worth allocated towards risk-free or low-risk investments in a bull market. Since 2009, I’ve come across many readers who saved diligently, but just let their savings pile up. As a result of not investing, they fell behind their peers.
The issue with getting rich is that you must take risks. Even if the NASDAQ closes up 43% again, as it did in 2020, you aren’t richer if everybody else is up 43%. To get rich, you must outperform various financial benchmarks.
In addition to investing during a bull market, you should also be more aggressive in your career. Ask for those raises and promotions when times are good. Look for new job opportunities that can immediately boost your compensation and title. In a bull market, demand for labor is high.
7) The Right Net Worth Allocation Will Be Responsible For Most Of Your Wealth Gains
Spending many hours trying to identify promising individual investments will likely be a waste of your time. We already know most professional money managers don’t outperform their target indices.
Therefore, instead of trying to pick the best individual security, focus on having the right net worth allocation first. Having the proper exposure to risk assets is the best way to build wealth over the long term.
Once you have the right net worth allocation, then you can slowly drill down to the types of funds, ETFs, individual stocks, and real estate investments you want to make.
Recommended Net Worth Allocation: Conventional
Let’s start with the Conventional net worth allocation model. The Conventional model consists of investments in Stocks, Bonds, Real Estate, and Risk-Free assets. It is the most basic net worth asset allocation model and also one of the most proven models over the decades.
For those of you who like to keep things simple and who are also fine with working until the traditional retirement age of 60+, the Conventional model is for you. Let’s go through some assumptions below.
Conventional Net Worth Allocation Model Assumptions
- The Stocks & Bonds allocations follow my stocks and bonds asset allocation by age. Please refer to the post and charts for details. The Conventional model suggests a 90%+ asset allocation into stocks in your 20s. Your 20s is a time to save aggressively and take maximum investment risk. Any losses can be easily made up by work income.
- At age 30, the Conventional model recommends buying a primary residence and having 5% of your net worth in risk-free assets. One of your main 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%.
- By age 40, the Conventional model suggests having a larger weighting in Stocks & Bonds versus Real Estate. As your net worth grows, your primary residence becomes a smaller and smaller portion of your overall net worth. At the same time, you may also be interested in investing in rental properties, REITs, or private eREITs to get long real estate instead of just neutral real estate.
- By age 60, the Conventional model recommends having roughly an equal weighting in stocks, bonds, and real estate (30%-35% each) with a 5% risk-free allocation. By age 60, you should be financially secure and should no longer need to take as much risk in the stock market. Bonds and real estate will provide the lion’s share of passive retirement income.
- All percentages are based on 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, and structured notes. Bonds include government Treasuries, corporate bonds, municipal bonds, high yield bonds, and TIPs.
- If you just don’t want to own physical property, then you should consider gaining real estate exposure through REITs, real estate stocks, and real estate crowdfunding. As you grow older, you may not want to own as much physical real estate due to tenant and maintenance issues. Real estate is one of the proven ways Americans have built wealth over the century.
- Alternative investments and your X factor 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.
Recommended Net Worth Allocation: New Life
The New Life net worth model changes things up around age 40. After living the Conventional way of life for years, you may want to experience a “new life” in the second half of your existence.
Since starting Financial Samurai in 2009, I’ve discovered many of us start wanting to do something new around age 40. Given you’ve had almost 20 years of learning, building wealth, and honing new skills, you may have a growing itch to try a new career, invest in different assets, or start your own side business.
Some call this a mid-life crisis. I like to think of this time as a period of discovery and excitement because you have a solid financial foundation. Therefore, you decide to take slightly more risk. At the same time, you can’t fully let go of the conventional way of life.
The New Life Framework essentially includes investments in more alternative assets like venture capital, private equity, building your own business, and consulting on the side.
New Life Net Worth Allocation Assumptions
- By age 30, you purchase your first property and allocate 5% of your net worth to risk-free assets like CDs now that you have a mortgage. 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.
- By age 40, your net worth has increased handsomely. Your real estate now accounts for a more manageable 40% of net worth compared to 90%+ for the typical American. You finally decide to diversify some of your risk assets into alternative investments like private equity, angel investing, art, farmland, and venture debt.
- Around age 40, you also start a side hustle while you still have a steady job. You’ve always wanted to consult on the side, start a blog, launch an e-commerce store, or teach music lessons online. Whatever your X factor is, you’re finally pursuing it under the safety of a regular paycheck. You’ve begun your new life!
- Also around age 40, you are beginning to wonder what else is there to life. You’re getting burned out after doing the same old thing for almost 20 years. Maybe you negotiate a severance before working in a different industry. Maybe you just take a long sabbatical and transfer departments. Or maybe you decide to join a competitor for a pay raise and a promotion.
- By the time you’re 60, you have roughly an equal balance between Stocks, Bonds, and Real Estate (20%-25%). Meanwhile, your Alternatives percentage rises to roughly 10% of your net worth. If all goes well, your X-Factor rises to about 20% of net worth because you’ve created a valuable asset.
- In your golden years, a diversified net worth provides stability and security as you plan to live until 110 years old. If you die before 110 years old, your estate will get passed down to your heirs and charitable organizations. You adopt more of the Legacy Retirement Philosophy.
Recommended Net Worth Allocation: Financial Samurai
The Financial Samurai net worth allocation model is one where you aggressively bet on yourself (X-Factor). You believe the traditional way of building wealth is outdated. You have no desire to work for someone else until your 60s. Instead, you want to build your own business and have more freedom at a younger age.
Despite your desire for more autonomy, you still diligently build your financial foundation in your 20s and early 30s. The 20s is when you’re learning so that you can start earning in your 30s and beyond. During this time period, you are also actively building your passive investment income streams.
Once your side hustle starts generating enough to cover your basic living expenses, you take a leap of faith and go all-in on your business or your desire for freedom.
Your financial goal is to build a new asset that makes up half or more of your net worth. Your lifestyle goal is to live life completely on your terms.
Let’s review some assumptions.
Financial Samurai Net Worth Allocation Assumptions
- The Financial Samurai model assumes you will have better control of your own financial future than other investments. When you invest in stocks, bonds, and real estate, you are a passive investor. You depend 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.
- One way to ascertain whether the Financial Samurai net worth allocation model is for you is to ask whether you can make a greater than 10% annual return from something you build. 10% is the average return of the S&P 500.
- By your late 20s, you get neutral real estate by owning your primary residence. You understand that it’s not good to fight inflation over the long term by renting. Your real estate and bond investments provide more stability as you seek to take more investment risks and work on your X factor.
- By your early 30s, you start aggressively going to work building your side hustle. After 10 years, you already know you don’t want to do the same job forever. You also know what you want to do after a decade of working. Your initial goal is to earn enough money from your side business to cover your basic living expenses. Once that is achieved, you will take a leap of faith.
- Before leaving your day job, you will negotiate a severance. There is no way you will leave money on the table after devoting years of excellence to your employer. With your negotiating skills and ability to create a win-win situation, you walk away from your day job with a nice financial buffer.
- Despite building your business, you are also focused on building as many passive income streams as possible through your Stocks, Bonds, and Alternative investments. Your goal is to build a large enough passive investment portfolio to cover your desired living expenses. In addition, you want a diversified enough portfolio to keep spitting out income no matter the economic condition.
- At the same time, you are also trying to generate profits from your entrepreneurial endeavor to either cover your desired living expenses, reinvest it into the business for potentially more profits, or reinvest it into more passive income investments. Your business income is essentially another income stream, albeit an active one.
- 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 Allocation Is Well-Diversified
So there you have it financial independence seekers. Following one of these three net worth allocation models during your lifetime should give you a great chance at eventually achieving financial freedom. At the very least, you should be able to achieve an above-average net worth.
Of course, we must recognize that financial returns are not guaranteed. Your financial journey will be full of twists and turns. As a result, it’s best to keep a diversified net worth mix that can withstand economic downturns. At the same time, your diversified net worth will also benefit from multi-year bull runs.
When it comes to building wealth, I encourage everyone to plan for bad scenarios as well. Expect the occasional 30%+ decline in your risk assets. This way, you will increase your chances of staying more disciplined when it comes to investing.
Remember, the average American has 90%+ of their ~$110,000 net worth in their primary residence. Meanwhile, roughly 35% of Americans don’t even own a home. This lack of net worth diversification is dangerous. It means the average American is not actively investing in other asset classes.
I do not recommend having more than 50% of your net worth in any one asset class after age 40. Once you’ve built a significant amount of wealth, your goal should start tilting towards capital preservation. The last thing you want to do is go back to the salt mines when you’re old and tired to make up for lost wealth.
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. You can always adjust your net worth asset allocation over time.
Finally, remember to enjoy your journey towards financial independence. Even if you amass enough wealth to never have to work again, you won’t magically feel happier. Make sure you always have a purpose to provide your life with constant meaning.
Suggestions For Building Wealth
1) Stay On Top Of Your Finances. To grow your wealth, I recommend using Personal Capital’s free financial app. I’ve been using them since 2012 to track my net worth, analyze my investments, and plan for retirement. I even spent a couple years consulting with Personal Capital in their San Francisco office.
2) Diversify Your Real Estate Investments. Instead of going all-in on real estate with a mortgage, be more surgical. Take a look at Fundrise, my favorite real estate platform to help you gain exposure in a much less volatile way. You can earn income 100% passively and diversify your exposure across America with Fundrise.
Readers, I’ve spent years updating my recommended net worth allocation models to help the majority of people try to achieve financial independence. I’d love to hear your feedback on how these net worth allocation models can improve. I’d also love to hear what your net worth allocation breakdown is. There is no one size fits all. However, I do believe these three models are relevant for 80%+ of the population.
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