What Is Asset Allocation?
We’ve all heard the saying: don’t put all your eggs in one basket. Maybe you’re not familiar with the term asset allocation, but in some ways it may be similar. Asset allocation is how you divide your savings—or “assets”—so you spread out your risks. For example, you may want to hold different types of investments, like a mix of stocks and bonds. Asset allocation is a key aspect of any investment strategy, and it’s especially important when you’re saving for retirement.
It can be difficult to choose which investments will consistently perform well. When you have a collection of investments that have different risk and return profiles, the ones that have increased in value may potentially more than offset the ones that have decreased in value over the long term. According to a 2014 TIAA-CREF analysis, portfolios with allocations to different types of stocks and bonds outperformed portfolios which only invested in one type of stock and one type of bond from 1999 to 2013. 1 It is important to be thoughtful about how you set your asset allocation and you don’t have to create the portfolio on your own. You can select an asset allocation portfolio that lets you identify your risk profile or retirement year and then requires very little maintenance, such as a balanced fund, risk-based portfolio or target retirement date portfolio.
How Do I Allocate My Assets?
How you allocate your assets depends on several factors, including what stage of your retirement planning you’re in. It also depends on what your goals are for retirement and how much risk you can tolerate. Some asset allocation portfolios are structured by risk level, so those may help you balance assets appropriately. Risk-based portfolios are often categorized in suites of aggressive, moderate and growth funds to correspond to risk level. This helps you get the right mix of asset classes: stocks, bonds, or other asset classes, based on your risk level to seek to meet your retirement goals.
Why Does the Portfolio Need to Be Monitored?
One reason you need to regularly monitor your asset allocation strategy or consider a prepackaged asset allocation portfolio is that in different types of market environments assets increase or decrease in value at different rates. Consider this example: a retirement portfolio of $100,000 has a mix of 60% stocks, 35% bonds, and 5% cash. A good year for the stock market might increase the portfolio’s stock holdings from $60,000 to $80,000 without changing the bond or cash holdings. The portfolio is now worth $120,000, but the asset allocation has changed, since stocks now account for 66% of the portfolio, bonds for 29%, and cash for 4%.
Some investment professionals recommend revisiting asset allocation at least once a year and making adjustments. However, a portfolio that automatically rebalances to maintain a proper asset allocation can help do this for you, for example, based on your risk level or target retirement date. The idea is to maximize your returns at a risk level that is comfortable for you so that you can work towards your retirement savings goal.