Your time and risk tolerance play a part in your retirement planning, and asset allocation can help by adjusting your investment risk to accommodate both.
If you’re like most people, your budget changes from year to year, even if it’s just a little as you evaluate goals and adjust for big shifts (a home, travel) and small changes (cancelling an unneeded subscription).
That analogy is a good way to think about asset allocation. It’s a key investing strategy, and understanding it can give you the tools to help shift and adapt over time to help you reach your short- and long-term retirement goals. What do you need to know to help asset allocation work for you? Here are some insights.
When retirement is decades away, your post-work goals may seem distant. But even as retirement nears, many people have a hard time with expectations versus reality.
Take retirement age: Most people expect it to be 65, but the median is actually 62.
Consider approaching retirement goals, budget, and timing like this: “I think … I want to travel when I retire. I know … I have put away X amount in retirement savings so far.” To help, map out estimates of retirement expenses and timing, both when you may withdraw from retirement savings and how long you think these savings will last. Again, this may be a combination of “think” and “know.”
Here’s where your goals and timing for retirement plug into your asset allocation.
From today until the day you retire is the total time that you have to build retirement savings. This period is crucial, because more time means more opportunity to compound growth and manage typical economic cycle ups and downs. How do retirement savings grow and recover in response to those cycles? That depends in part on their distribution among asset classes.
When you put money into something like a 401(k), you typically choose a fund to invest in. That fund isn’t made up of just stocks in one company or a single type of bonds; it’s a mix of asset classes, or types.
In general, there are three basic asset classes: cash, fixed income, and equities. The three rarely move in tandem; some may make gains while others hold steady. So, each offers its own risk and return potential, and thus serves its own purpose for your investing goals.
| Asset class | Examples | Risk and return |
|---|---|---|
| Cash | Money market funds and certificates of deposit | Most stable, lowest potential return |
| Fixed income | Bonds | Stable, more growth opportunity than cash |
| Equities | Stocks | More risk, but more opportunity for return over time |
Much like asset classes vary in their level of risk, people do, too; that’s what’s called risk tolerance. There are different types of risk tolerance, and ways to figure out what your comfort level with risk is. But in general, as you approach retirement, your tolerance for risk lessens.
The best asset allocation for you is the just-right mix of investments that balances your tolerance for risk and potential reward for your dollars invested over time. “Asset allocation works in tandem with your comfort with risk; it helps set the foundation for the success of your investment strategy,” Winston says.
Diversification is key. Even though a certain percentage of your savings is invested in stocks, the investment manager typically won’t buy all the same types of stocks. They’ll have a mix across business types and even geography, to name just two factors. The idea is that diversification offers balance; if the tech stocks have a rough stretch, a different industry may experience growth.
There are lots of different approaches to asset allocation. For example, the three buckets approach splits investments across classes to build stability but take advantage of growth potential to meet near-, medium-, and long-term needs.
Some investment products have built-in asset allocation that adjusts over time; these are typically called target date funds or life cycle funds. Or, a managed account product may offer even more personalization in asset allocation to meet your specific goals.
Over time, your original asset allocation can get out of alignment with your original goals. Say you chose a fund with a 50-30-20 (stocks, bonds, cash) mix. Your cash investments grew a little but your stocks grew a lot; your total investments, then, may end up more heavily weighted toward stocks because of that asset class’s growth. Rebalancing helps fix that; think of it like a re-set to help maintain your original targets.
- Stocks
- Bonds
- Cash
For illustrative purposes only.
But here’s the key: To meet your retirement goals—growth over long term, stability in the near term—your asset allocation has to change over time. You’ll necessarily want to shift to heavier allocations in cash and bonds as retirement gets closer, trading growth potential for stability.
A tax advisor and financial professional can help discuss your options and the asset allocation and rebalancing schedule that best helps you reach your goals.
Want to check your investment mix and rebalance your account? Login; on your dashboard, find your accounts on the left-hand side. Click the account to research; then click “Investments” on the top menu. Scroll down to “Investments summary”; your investment mix will display on the right-hand side, look for the “rebalance” option.
