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Asset Allocation Made Simple
As you accumulate retirement assets, the most important decision you need to make is how the assets are going to be invested.
The allotting of your retirement assets across stocks, bonds, money market, and other investments is referred to as asset allocation. Your asset allocation decision, more than most other decisions, will determines how fast your retirement account will grow. Is it difficult to do? Not really, but like most investment issues you do need to know some basics.
- Invest for the Long-term: Once you set your allocation, be patient. Discipline yourself to maintain your allocation through down markets as well as up markets.
- Invest for Growth: Equity mutual funds (stocks) need to be an important part of your allocation, even in retirement. Don't worry about short-term ups and downs in the stock market. Over time, stocks have usually outperformed all other types of investments while staying ahead of inflation. Make equity mutual funds the core of a long-term investing strategy.
- Know Yourself: Understand your tolerance for risk. Ask yourself, "Can I sleep at night with my retirement dollars allocated this way?" If the answer is no, make a change. Don't create undue emotional stress.
- Diversified Your Portfolio: This is what good asset allocation is all about. Don't put all your assets into one asset class. Spread them among different asset classes and investment styles. Doing so will spread your assets over an assortment of investments and should reduce your risk. You can learn more about asset styles by clicking here.
- Review Annually: Take the time once a year to review your life circumstances and long-term goals. Based upon the results of your review, adjust your allocation. Even if nothing has changed, you may need to rebalance your portfolio to bring it back into line with your allocation objectives.
- Fees and Costs: Like everything, mutual funds and other 401k investment options carry costs, and they can vary greatly from fund-to-fund. Since high fund costs can impact your long-term investment earnings, you need to know what the fees are -- so ask.
You must make your own allocation decisions based upon your individual situation, but we can give you some general "rule of thumb" asset allocations based upon age. You can use these as a starting point. We assume retirement at age 65.
- Age: Less Than 40 -- 100% in equities. Of this, 40% invested in large cap. growth funds, 25% small cap. growth funds, 25% in large cap. value funds, and 10% international. Another option is to use several good index funds.
- Age: 40 to 50 -- 80% in equities and 20% in fixed income. Of the equity portion, 40% invested in large cap. growth funds, 25% small cap. growth funds, 25% in large cap. value funds, and 10% international. Another good option for your equity portion is to use good index funds.
- Age: 51 to 55 -- 70% in equities and 30% in fixed income. Of the equity portion, 40% invested in large cap. growth funds, 25% small cap. growth funds, 25% in large cap. value funds, and 10% international. Another good option for your equity portion is to use good index funds.
- Age: 56 to 60 -- 50% in equities and 50% in fixed income. Of the equity portion, 40% invested in large cap. growth funds, 10% small cap. growth funds, 40% in large cap. value funds, and 10% international. Another good option for your equity portion is to use good index funds.
- Age: 61 to 65 -- Reduce equities by 5% per year and increase fixed income by 5% per year so that at retirement you have 25% in equities and 75% in fixed income. Of the equity portion, 40% invested in large cap. growth funds, 10% small cap. growth funds, 40% in large cap. value funds, and 10% international. Another good option for your equity portion is to use good index funds.
Target-Date Funds
As you may have learned, trying to make well-informed asset allocation decisions is not easy. One investment alternative that has surged in popularity over the past years is called a target-date fund. With this type of fund, the fund manager will make the asset allocation decisions for you according to the amount of years you have until retirement. They automatically rebalance the fund to become more conservative as you gets closer to retirement. It's like putting your 401k account on autopilot.
Most 401k plans today offer target-date funds, so check with your plan administrator to see what is available to you.
Additional Reading
The Value of Asset Allocation, Boost Your 401k Returns by Rebalancing, and Nurture Your 401k Portfolio Using Asset Allocation.
This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
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