Asset Allocation – Five Things You Should Know

Asset Allocation

When it comes to having a comfortable retirement, sound planning is essential. To start working toward your investment goals, you’ll need to consider several things for asset allocation. In case you don’t know, asset allocation involves diversifying your retirement accounts, including cash, stocks, and bonds.

As part of managing your allocation, certain factors, like your age, come into play. Generally speaking, as you get older, you can’t afford to take much risk. As you near the age of retirement, any risk tolerances decrease substantially. At the same time, you won’t be in a position to deal with significant fluctuations in your account balance.

With these five best practices, you can successfully manage your asset allocation.

Make Adjustments Based on Age

When facing a short investment timeline, market corrections create challenges, not just from a financial standpoint but also an emotional one. Issues might prompt you to sell stocks at a loss, causing you to miss an opportunity for recovery. Emotionally, market corrections can create a lot of stress. Often, that prompts people to make bad selling decisions.

To avoid these issues, and if you’re not yet 50 but still saving for your retirement,think about investing heavily in stocks. As you get closer to the age of 50, you could allocate 60 percent of your portfolio to stocks, with the remaining 40 percent going to bonds. Remember, you can always adjust these figures based on your risk tolerance.

Once you’ve retired, you can go with a more conservative allocation again, making adjustments to your risk tolerance. Regarding any money you’ll need over the next five years, either go with investment-grade bonds or keep it in cash. However, your emergency fund should all be in cash so that you have quick and easy access to it if needed.

You can have a financial planner help you figure out the best asset allocation based on your age and risk tolerance. You can also do this yourself with financial planning software such as WealthTrace, which allows you to run detailed what-if asset allocation scenarios. You could also start with a simple calculator, such as Bankrate’s asset allocation calculator.

Look at Innate Risk Tolerance in Addition to Your Age

For this, there are two good rules to follow. Rule 100 determines the percentage of stocks you want to hold onto by subtracting your current age from the number 100. Rule 110 is an extension of Rule 100, per se. Considering that people now live longer than before, it works the same way, except that you would subtract your age from the number 110 instead of 100.

Here’s an example. If you go with Rule 100, at the age of 60, you’d want 40 percent of your portfolio in stocks. Ultimately, both rules work by determining your ideal asset allocation based on your age and how much time you have until retirement. Since innate risk tolerance includes other factors, it’s vital to speak with a reputable financial advisor for guidance.

Don’t Allow Market Conditions to Drive Your Strategy for Allocation

During a strong economy, it’s easy to get fooled into believing that the stock market will keep rising. When that happens, people tend to hold onto more stocks as a way of achieving higher profits. You don’t want to do that. Instead, you need a planned strategy for asset allocation that you follow faithfully, regardless of market conditions.

Use Asset Classes to Diversify Your Holdings

Yes, the diversification of stocks, bonds, and cash is essential. But at the same time, you want to diversify within each of these asset classes.

  • Stocks – The goal is to hold at least 20 unique stocks, or you can invest in either exchange-traded funds or mutual funds. That lets you diversify your holdings by company or sector. The most stable typically include healthcare, utility, and consumer staple companies. In comparison, the financial and technology industries react more to economic cycles. However, since exchange-traded funds and mutual funds are already diversified, they are an excellent option if you have a small amount of money to work with.
  • Bonds – To diversify these holdings, invest in bond funds. Another option is to choose a variety of holdings across different sectors, types, and maturities. The most common bonds include government, municipal, and corporate.
  • Cash – Unlike stocks and bonds, cash in a bank doesn’t lose value. Therefore, you don’t need to be in a hurry to diversify this. However, if you have a substantial amount of cash, consider putting it into several FDIC-insured banks since there is a $250,000 limit of protection per depositor per bank. If you don’t have a lot of money, you can continuously diversify how you hold your cash. This will help increase both interest earnings and liquidity.

Allow a Target-date Fund to Manage Your Asset Allocation

When it comes to asset allocation, many different rules and strategies exist. For a lot of people, it becomes confusing. If you’re among them, why not allow a target-date fund to manage your asset allocation on your behalf? This type of mutual fund holds multiple asset classes.

As the target date draws closer, this type of fund transitions into a more conservative allocation. With this, the fund’s name is the target date for your retirement. It also includes the year that you want to retire. Not only does a target-date fund diversify across and within different asset classes, but it also uses your age. Because the fund does the work, there isn’t much for you to manage.

Now, there are a couple of drawbacks. Unlike the other options, a target-date fund doesn’t factor in your risk tolerance or possible changes. For example, say you got promoted at work, which included a significant pay increase that would allow you to retire earlier than planned. However, if that occurred after you started using a target-date fund, it wouldn’t recognize the change. So, you’d need to reassess its value.

Final Thoughts

Along with the rules mentioned for managing asset allocation, you can always develop some rules of your own. After all, there isn’t just one approach that works perfectly. Again, this is why it’s so important to consult with a financial advisor. That way, you get the most “bang for your buck” upon retirement.

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