Asset Allocation - Five Things You Should Know (2024)

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.

Aspart of managing your allocation, certain factors, like your age, come intoplay. 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 fluctuationsin your account balance.

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

Make Adjustments Based on Age

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

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

Once you’veretired, you can go with a more conservative allocation again, makingadjustments to your risk tolerance. Regarding any money you’ll need over thenext 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 andeasy 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, thereare two good rules to follow. Rule 100 determines the percentage of stocks youwant to hold onto by subtracting your current age from the number 100. Rule 110is an extension of Rule 100, per se. Considering that people now live longerthan before, it works the same way, except that you would subtract your agefrom the number 110 instead of 100.

Here’s anexample. If you go with Rule 100, at the age of 60, you’d want 40 percent ofyour portfolio in stocks. Ultimately, both rules work by determining your idealasset 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 areputable financial advisor for guidance.

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

During a strongeconomy, it’s easy to get fooled into believing that the stock market will keeprising. When that happens, people tend to hold onto more stocks as a way ofachieving higher profits. You don’t want to do that. Instead, you need aplanned strategy for asset allocation that you follow faithfully, regardless ofmarket 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 isto hold at least 20 unique stocks, or you can invest in either exchange-tradedfunds or mutual funds. That lets you diversify your holdings by company orsector. The most stable typically include healthcare, utility, and consumerstaple companies. In comparison, the financial and technology industries reactmore to economic cycles. However, since exchange-traded funds and mutual fundsare already diversified, they are an excellent option if you have a smallamount of money to work with.
• Bonds – To diversifythese holdings, invest in bond funds. Another option is to choose a variety ofholdings across different sectors, types, and maturities. The most common bondsinclude government, municipal, and corporate.
• Cash – Unlike stocksand 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 asubstantial amount of cash, consider putting it into several FDIC-insured bankssince there is a $250,000 limit of protection per depositor per bank. If youdon’t have a lot of money, you can continuously diversify how you hold yourcash. This will help increase both interest earnings and liquidity.

Allow a Target-date Fund to Manage Your Asset Allocation

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

As the targetdate draws closer, this type of fund transitions into a more conservativeallocation. 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-datefund diversify across and within different asset classes, but it also uses yourage. Because the fund does the work, there isn’t much for you to manage.

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

Final Thoughts

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