As you approach or enter retirement, managing your investments becomes not just about growing your wealth but also about preserving what you have accumulated over the years. Strategic asset allocation—the way you divide your investments among different types of assets such as stocks, bonds, and cash—is a crucial component of this management.
What Exactly is Asset Allocation, and Why Does it Matter?
Asset allocation involves the strategic distribution of your investments across different asset classes. Asset classes you might use include stocks, bonds, real estate, cash equivalents, and others.
Diversifying beyond one asset class is important in case something happens to a particular asset class. By spreading your investments across various asset classes with differing risk and return profiles, you can mitigate the impact of volatility and potentially enhance your overall returns.
A downturn in stocks, bonds, real estate, or some other asset class will only affect a portion of your portfolio, rather than most or all of it. You may also realize greater gains if any one of these sectors grows more than others.
Determining An Investment Mix Best for You
Your chosen asset allocation will depend on your specific financial goals, risk tolerance, and investment horizon. It’ll also take into account your needs, whether those include guaranteed income, portfolio growth, capital preservation, or other particular needs.
Some specific factors to take into account are:
- Time Horizon: Your time horizon refers to the duration you have until you need to access your retirement funds. If you have a longer time horizon, you might choose to take more risk for potentially higher returns. A shorter time horizon might warrant a more conservative approach.
Keep in mind that your time horizon will obviously change as you age, and you could have different horizons for different accounts. - Risk Tolerance: How much risk you’re comfortable with is a personal decision, and can also change with age, health, or financial circumstances. Your risk tolerance will impact the ratio of less conservative to more conservative investments.
- Financial Goals: Whether you aim to leave a legacy, support a hobby, travel, or preserve your wealth, your goals will substantially affect how you should invest. This and your personal risk tolerance will largely determine your overall portfolio’s risk-reward profile.
- Market Conditions: Sometimes different economic conditions favor one asset or another. Changes may warrant small or moderate adjustments to your portfolio’s asset allocation.
Many people find it helpful to discuss these factors with someone else. While each is personal, it’s helpful to have a knowledgeable and objective person work through your decisions. That could be a financial advisor if you want specific guidance on market conditions, financial goals, or risk tolerance. At the very least, discuss your time horizon and goals with a trusted family member or friend.
Investment Vehicles and Asset Allocation
There are many different investment vehicles that might be included in a well-balanced portfolio. Some of the most common investment assets are:
1. Stocks and Mutual Funds
These are generally investments in companies. They offer potential growth, and sometimes regular dividends.
Stocks carry some risk, but they’re broadly considered an important part of most people’s retirement portfolios. Mutual funds are mostly collections of stocks.
2. Bonds
Bonds can represent investments in public works projects, corporate projects, or other large undertakings. They may provide guaranteed fixed returns or variable returns.
Most bonds are considered to be more conservative than stocks, offering less growth potential but presenting less risk. They may have a place in many people’s portfolios, especially those who want a more conservative asset allocation.
3. Real Estate and REITs
Real estate is often investments in residential or commercial buildings, but it’s possible to invest in other types of land. Investments might provide regular income, possible appreciation, and tax benefits. Those are perks that many retirees appreciate.
The method you use to invest in real estate would depend partly on how hands-on you want to be. Options include purchasing and managing properties yourself, purchasing properties that are managed by a property management company, or REITs. REITs are akin to mutual funds but for real estate, granting exposure to larger properties without requiring a lot of capital or time.
4. Annuities
Annuities usually provide a certain amount of guaranteed income, and also a certain amount of growth. Growth might be fixed, meaning it’s a set amount, or variable, in which case it’s often pegged to an index. Lump sum annuities, deferred annuities, life annuities, and others offer various solutions that combine income and growth potential.
Annuities may have a role in your portfolio if you’d like some potential upside, but also value having another known income source.
5. Cash and Cash Equivalents
No matter your risk tolerance, it’s usually advisable to keep at least some savings readily available. These investments are referred to as “cash and cash equivalents.” Their purpose isn’t growth, but rather liquidity should you need funds quickly (e.g. for an emergency).
Keeping large amounts of actual cash on hand presents obvious risks, so most people choose other options. You might keep funds in a checking account, high-yield savings account, money market account, or similarly liquid investment. (Liquidity refers to how quickly funds can be accessed.)
6. Certificates of Deposit
CDs usually provide a guaranteed return if you’re willing to lock up funds for a certain amount of time (e.g. months or years). These may preserve capital while providing a slight hedge against inflation. Some CDs qualify as cash equivalents, but not all do.
7. Precious Metals
For investment purposes, the main precious metals are usually gold, silver, platinum, and palladium. When included in a portfolio, they usually account for a relatively small percentage of the portfolio. Their purpose is primarily to hedge against inflation and provide diversification.
8. Other Investments
There are still many other investments, such as cryptocurrencies, commodities, collectibles, artwork, and many others. Such investments aren’t often recommended unless they’re specifically relevant for some reason (e.g. you’ve spent a career curating artwork). Even then, alternative investments typically should make up only a very small percentage of a portfolio.
Getting Help Evaluating Options
So many potential asset classes present many different choices when determining how to structure a portfolio, and these decisions don’t even take into account the process of choosing specific investments within an asset class.
A financial advisor can help evaluate the various investment vehicles, providing personalized input as to which ones likely fit your age, risk tolerance, and goals. If you’d like to talk with a financial advisor, we can match you with a qualified advisor.
Advanced Retirement Asset Allocation Strategies
Asset allocation involves more than just a one-time decision about assets. It’s an ongoing process that can include several more advanced retirement asset allocation strategies. A few are:
- Time-Segmentation: Assets are divided into time-based segments, matching different liquidity, growth, preservation, and income needs at different stages.
- Rebalancing: The selling of some assets and buying of others, to restore your target percentages after a gain, loss, or withdrawal that primarily impacts one asset class or account.
- Tax Implications: Using specific tax strategies to reduce the taxes that are/will be owed. Tax-loss harvesting, where a loss is used to offset a gain for tax purposes, is one frequently used strategy.
Avoiding Common Asset Allocation Mistakes
Wise asset allocation isn’t only about making smart decisions, but also avoiding some common mistakes. Retirees are sometimes prone to:
- Overconcentration: The specific purpose of asset allocation is to avoid overconcentration in any one asset class, by diversifying across several different ones.
- Overly Conservative: There’s a role for conservative investments, and that role may increase with age. Growth shouldn’t be totally ignored, however, considering how long life expectancies can be.
- Overly Aggressive: Aggression to the point that a retirement fund is substantially exposed to loss can be devastating, as there might not be time to recover from a major downturn.
- Chasing Performance: Avoid making impulsive decisions based on short-term market fluctuations, instead staying with an informed long-term plan.
- Neglecting to Rebalance: Without regular rebalancing, a portfolio can become too concentrated, too risk-oriented, or too conservative. Managing asset allocation doesn’t require constant vigilance, but does need to be updated periodically.
- Ignoring Tax Implications: When selling assets for rebalancing or withdrawing, failing to account for taxes can be costly.
If you aren’t experienced in asset allocation and retirement planning, it’s easy to make these mistakes. Working with a financial advisor could help you avoid many of them.
How Financial Advisors Simplify Asset Allocation For Your Retirement
Asset allocation is fairly simple in principle, but can be complex when making decisions and executing those decisions. A financial advisor can help with the details in multiple ways:
1. Goals and Risk Tolerance Assessment
Your goals and risk tolerance are your decision, but it’s helpful to have someone knowledgeable work through the thought process with you. A financial advisor will have helped others determine their financial goals and risk tolerance, and they’ll be able to walk you through the different considerations that should be taken into account.
2. Personalized Strategies
Proper asset allocation is based on your personal choices and situation. While diversification principles broadly apply, exactly how they apply depends on your risk tolerance, income needs, time horizon, and much more.
You can find general financial advice online and through other resources. A financial advisor can give you much more personalized advice, working to find an asset allocation strategy that’s right for you.
3. Investment Advice
Once your general strategy is decided, a financial advisor can provide specific recommendations on assets. They can both recommend asset classes, and specific investment options within asset classes.
Their recommendations will be based on your decisions, and also their detailed knowledge of market conditions. They have professional knowledge of current market trends and historic asset performance, bringing a level of knowledge that most individuals don’t have.
4. Monitoring and Rebalancing
Few people want or have the time to vigilantly monitor their portfolio’s performance. That’s a financial advisor’s job — they’ll watch your portfolio for any changes. They’ll then consult you, rebalance the portfolio, or otherwise adjust as you’ve asked them to.
5. Tax Optimization
From tax-loss harvesting to retirement account withdrawals, a financial advisor can help reduce the capital gains and income taxes you owe. The reduction in taxes owed can be thousands or tens of thousands, depending on your situation, investments, and actions.
6. Ongoing Education
A good financial advisor will spend time helping you better understand asset allocation, investing, and retirement planning. They’ll explain decisions to you, and generally educate you on retirement planning and portfolio management.
Find a Financial Advisor Who’s Right for You
Just as your asset allocation should be specifically right for you, your financial advisor should also be right for you. There are many qualified financial advisors, but not all are right for all individuals. You want someone who’ll discuss your situation, understand your needs, and help you decide on an appropriate asset allocation.
Our financial advisor matching method can help you find that right advisor. Answer a few simple questions, and let us at Invested Better find a qualified financial advisor who can assist you.
General Disclaimer: The information provided on this site is for informational purposes only and should not be construed as financial advice. Invested Better does not guarantee the accuracy or completeness of the information provided. Please consult with a licensed financial advisor before making any financial decisions.
Investment Risk Disclaimer: Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results.
