The balance between stocks and bonds — and the ETFs based on them — is usually expressed as “[% stocks]/[% bonds],” so a 60/40 portfolio means 60 percent stocks or stock ETFs and 40 percent bonds or bond ETFs. The optimal balance for any given person depends on many factors: age, size of portfolio, income stream, financial responsibilities, economic safety net, and emotional tolerance for risk.
In general, working investors should hold three to six months of living expenses in cash (money markets or Internet savings accounts) or near-cash (very short-term bond funds or short-term CDs). Non-working investors living largely off their portfolios should set aside much more, perhaps one to two years of living expenses.
Beyond that, most people’s portfolios, whether they’re working or not, should be allocated to stocks (including REITs), intermediate-term bonds, and perhaps a few alternative investments, such as market-neutral funds and commodities (including precious metals).
In determining an optimal split, pick a date when you think you may need to start withdrawing money from your nest egg. How much do you anticipate needing to withdraw? Maybe $30,000 a year? Or $40,000? If you haven’t given this question much thought, please do!
Start with your current job income. Subtract what you believe you’ll be getting in Social Security payments or other pension income. The difference is what you would need to pull from your portfolio to replicate your current income. But most retirees find they need 80 to 90 percent of their working-days income to live comfortably.
Take a minute, please. Come up with a rough number of how much you’re going to need to take from your nest egg each year.
Got it?
Whatever the number, multiply it by 10. That amount, ideally, is what you should have in your bond portfolio, at a minimum, on the day you retire. In other words, if you think you’ll need to pull $30,000 a year from your portfolio, you should have at least $30,000 in cash and about $300,000 ($30,000 × 10) in bonds. That’s regardless of how much you have in stocks.
So here’s the rough rule (keeping in mind, please, that all rough rules can get you into trouble sometimes): If you are still in your 20s or 30s and want to keep the vast lion’s share of your portfolio in stocks, fine.
But as you get older and start to think about quitting your day job, begin to increase your bond allocation with the aim of getting to your retirement date with at least ten times your anticipated post-retirement withdrawals in bonds. Most people (who aren’t rich) should have roughly one year’s income in cash and the rest in a 50/50 (stock/bond) portfolio on retirement day.
With at least one year’s living expenses in cash and ten years of living expenses in bonds, you can live off the non-stock side of your portfolio for a good amount of time if the stock market goes into a swoon. (You then hope that the stock market recovers.)
If this rule seems too complex, you can always go with an even rougher rule that has appeared in countless magazines. It says you should subtract your age from 110, and that’s what you should have, more or less, in stocks, with the rest in bonds.
So a 50-year-old should have (110 – 50) 60 percent in stocks and 40 percent in bonds. A 60-year-old would want a portfolio of about (110 – 60) 50 percent stocks and 50 percent bonds. And so on and so on. This rough rule may not be bad, assuming that you are of average wealth, are going to retire at the average age, will live the average life expectancy, and expect that the markets will see roughly average performance!
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Source:http://www.dummies.com/how-to/content/exchange-traded-funds-finding-a-stock-to-bond-spli.html
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