I read recently that some financial advisers recommend an age-based approach to the split that you should have between savings and shares in your financial portfolio. The rule being exposed was as follows: If you're 30, you should have 30% in savings and 70% in shares. If you're 50, you should have 50% in savings and 50% in shares.

This theory, however, is controversial as it takes no account of the individual's circumstances. For example, how much disposable income do they have? What's their attitude to risk? When do they intend to retire?

I also saw a very committed share holder who argued that investors should have as close to 100% of their money in shares, given that shares have always (in the long-term) outperformed deposit accounts. He said he was in his fifties and had about 99% of his money in shares.

I think this approach is also flawed. It means that you would have little or no safety net if you found yourself suddenly facing unexpected costs, such as medical treatment or the need to repair storm damage to your house. Of course, you could sell some of the shares but that could mean selling at a loss if the stock market happens to be at a low point when you need to release the capital.

My view on this issue is that the optimal percentage to hold in shares needs to be determined in relation to financial goals and attitudes to risk, perhaps combined to a lesser extent with proximity to retirement.

Let's assume that you're 40 and you've decided that you want to retire early at the age of 55. You earn a decent salary of $60,000 but when you review your finances you find that you have a shortfall to be able to fund that early retirement goal. In this situation, you might decide to aggressively invest in the stock market and just maintain a small savings fund as a buffer against unexpected costs. Maybe the optimal split, therefore, for you might be 80 or 90% shares, 20 or 10% savings. You're accepting the greater risk of shares over savings in return for the prospect of a higher return.

There could however, equally, be another 40 year old who has two kids to put through college and doesn't intend to retire until 65. They have a conservative attitude towards money and just want to make sure that they can give each of their kids $20,000 towards the costs of college. For them, putting money aside into a high interest deposit account, or savings bond, may meet their needs better. They have the peace of mind of knowing that they will be guaranteed to compile the required amount of money as long as they put a set amount each month into the savings account.

It would, in some ways, be nice if there was a simple formula that we could use to tell us how much of our investments should be in shares and how much in savings. However, this is an overly simplistic approach and the reality is that the appropriate split will be determined by your personal circumstances and financial goals. It is however a very important question to consider, as getting it wrong could mean that you fail to meet your financial objectives.

Learn more about this author, Simon Wright.
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