Topics
Asset Allocation in the Golden Years
As you near retirement, it is important to estimate your future income needs and
identify potential sources of retirement income. For most people, Social Security
and pension income are not enough to get by. A portion of their retirement income
must come from retirement savings and personal investments. Accordingly, once
you transition into retirement, you will most likely need to shift the composition
of your investment portfolio to accommodate your changing needs. Exactly how you
choose to allocate your portfolio among different asset classes and investments
will depend upon a number of factors, including your age, tolerance for risk,
and the degree to which you rely on personal investments to fund your retirement.
Back to top
Why Asset Allocation Matters
Asset allocation refers to the way in which you divide your portfolio among
stock, bond, and cash investments. It is the single most important determinant
of long-term returns for a given portfolio. Within each of these broad categories,
there are many types and styles of investments, each with varying risk and growth
characteristics. The asset classes you choose, and how you weight your investment
in each, will largely determine your overall portfolio risk and long-term returns.
Following are three examples of typical retirement portfolio allocations that
may shed some light on your own investment priorities. Keep in mind that these
examples are hypothetical and your own circumstances will vary.
Back to top
Conservative Retirement Portfolio
A conservative retirement portfolio is usually more "conservative"
than a preretirement portfolio, where investors are less concerned with current
income and are generally willing to take on greater risk. The allocation of
a conservative retirement portfolio might be 30% cash, 50% bonds, and 20% stocks.
Such a portfolio would have produced an average annual yield of 4.8% and an average
total return of 8.3% during the 20 years ended December 31, 2006.
Such a portfolio might be suitable for older investors well into retirement
or for those who have not accumulated significant savings for retirement and
rely heavily on Social Security. A conservative allocation may also be appropriate
for risk-averse investors. Note, however, that a stock component is still an
important allocation if the portfolio is to grow and outpace inflation.
Different allocations may also affect how much of your portfolio principal
you choose to withdraw each year. Generally, the more conservative the portfolio,
the lesser the growth potential and the smaller the payout, although one's
personal situation and risk comfort level will ultimately determine your withdrawal
rate. Investors opting for a conservative allocation might consider a principal
payout of between 3% and 5% each year, depending on the size of their portfolio
and other individual circumstances.
Conservative Retirement Portfolio
Back to top
Moderate Retirement Portfolio
A "moderate" retirement portfolio might consist of 20% cash, 40%
bonds, and 40% stocks. This portfolio could suit a broad range of retirees of
varied age and risk comfort levels. A moderate allocation may be suitable for
investors who retire when eligible for full Social Security benefits, for those
who have accumulated a moderate retirement portfolio through IRAs and 401(k)
plan participation, and who may supplement their retirement income through part-time
work or by cashing in on home equity. Such a portfolio would have produced an
average annual yield of 4.3% and average total return of 9.4% during the 20
years ended December 31, 2006.
Investors choosing a moderate allocation might consider a principal payout
of between 4% and 6% each year, depending on the size of their portfolio and
other individual circumstances. Again, your withdrawal rate will depend on
your personal situation.
Moderate Retirement Portfolio
Back to top
Aggressive Retirement Portfolio
An "aggressive" retirement portfolio is best suited for investors
with a high tolerance for risk and for those who retire early and anticipate
many years in retirement. It also may be appropriate for those with a sizeable
nest egg who do not rely heavily on Social Security or pensions as sources of
retirement income. The allocation of an aggressive retirement portfolio
might be: 20% cash, 30% bonds, and 50% stocks. Such a portfolio would have produced
an average annual yield of 3.9% and average total return of 9.8% during the
20 years ended December 31, 2006.
Investors choosing an aggressive allocation might consider a principal payout
of between 5% and 7% each year, depending on the size of their portfolio and
other individual circumstances.
Aggressive Retirement Portfolio
Back to top
Next Step: Choosing Specific Investments
Once you've determined an appropriate asset allocation, you'll need to select specific investments for each asset class. The choice of investments within each class can be daunting. Stock investments, for instance, can be broken down into many subcategories based on company size, industry sector, or geographic location. And within each of these categories, there are thousands of companies and funds to choose from. A financial advisor can help you choose the individual investments that work best for you.
When selecting investments, be sure to avoid concentrating your assets in a
particular company, sector, or investment type. Mutual funds can help you reduce
this risk by diversifying among many different securities. They also carry the
advantage of professional management and can be matched to fit specific asset
classes.
Back to top
Summary
- How you choose to allocate your portfolio among different asset classes and investments will depend on a number of factors including your age, your tolerance for risk, and the degree to which you will rely on your personal investments to fund your retirement
- Asset allocation is the single most important determinant of long-term returns for a given portfolio. The asset classes you choose, and how you weight your investment in each, will largely determine your overall portfolio risk and long-term returns.
- A "conservative" retirement portfolio might be suitable for older investors well into retirement, for those who have not accumulated significant savings for retirement and/or rely heavily on Social Security, or for risk-averse investors.
- A "moderate" retirement allocation may be suitable for investors who retire when eligible for full Social Security benefits, who have accumulated a moderate retirement portfolio through IRAs and 401(k) plan participation, or who may supplement their retirement income through part-time work or by cashing in on home equity.
- An "aggressive" retirement portfolio may be best suited for investors with a high tolerance for risk, for those who retire early and anticipate many years in retirement, or a sizeable nest egg and will not rely heavily on Social Security or pensions as sources of retirement income.
- When selecting specific investments for each asset class, it's a good idea to diversify your holdings whenever possible to reduce portfolio risk.
Checklist
- If your financial outlook has changed, or if investment performance has caused your asset allocation to change, consider rebalancing your portfolio as soon as possible.
- Regardless of your "big picture" asset allocation strategy, be sure to diversify the investments you own within each asset class.
- Maximize contributions to retirement savings accounts while you're still in the workforce.
- Consider consulting a financial professional for advice about appropriate asset allocation strategies and to review your entire range of plans for retirement.
