Retirement asset allocation: find your financial balance

Transitioning into retirement is a big leap, no matter what level of income you earn. With major life changes and critical financial decisions on the horizon – not to mention the current economic outlook and the rapidly shifting retirement landscape – approaching this life stage can quickly become overwhelming.

Fortunately, maintaining a well-balanced portfolio can help take the pressure off, and it doesn’t have to be a daunting task. But how do you know if your investment strategy can get you to your retirement goals?

A retirement asset allocation strategy aims to balance the right mix of stocks, bonds, cash and other assets in your investment portfolio to outline a glide path toward (or through) your retirement. As you approach this horizon, your distribution will likely shift to help ensure you have a stable income later in life while hopefully continuing to generate investment earnings.

Usually, investors work with their financial advisors to craft a well-thought-out plan that involves distributing investments across different asset classes with a focus on balancing risk and potential return. For instance, many people have a greater risk appetite while they’re younger, choosing to invest more in the stock market than in bonds. As they near retirement, they begin to adjust this ratio by investing more in bonds with varying maturity dates.

Of course, not everyone will share the same risk threshold or time horizon. Some people may prefer to hold a more aggressive portfolio that prioritizes short-term growth. So, is one investment option better than the other as you approach retirement?

The short answer is there is no such thing as a perfect asset allocation. Your retirement portfolio’s balance will depend on a wide range of factors, from your risk tolerance and timeline to your investment objectives and personal circumstances. Age is a common first consideration, but it’s also important to think about other factors, such as whether you want to leave your wealth behind or spend all of your retirement savings. A financial advisor can help guide you through these considerations to design an investment strategy for you and your goals.

When it comes to determining a retirement asset allocation, investors often focus on the two major factors: age and risk.

An age-based approach to allocation adjusts your portfolio balance as you age. Typically, this means reducing your investment risk by targeting safer, more stable securities closer to retirement. For example, you may have heard of the rule of 100. The basic idea is you subtract your age from the number to determine the proportion of stocks to bonds you should own.

If you’re 40 years old, the rule advises you to hold 60% of your portfolio in the stock market with the other 40% going to bonds. But this rule of thumb is by no means a sure-fire retirement plan – for one, it can misdirect folks into being too conservative. Some clients who are 65 years old should consider having more than 35% exposure to stocks during their retirement in order to help achieve their goals of not outliving their money.

On the other hand, risk-based allocation considers the individual investor’s personal risk tolerance when developing a retirement investment strategy. This approach tends to focus more on your peace of mind when determining where your money should go. For instance, if you’re 40 years old with a solid retirement savings plan but you’re worried about a declining market, you could allocate more of your portfolio to cash and/or bonds. This strategy may come with less return, but it might help you worry less and sleep better at night.

If you prefer a more hands-off approach, you might consider a target date fund. This is a type of mutual fund that operates on a preset schedule, gradually and automatically adjusting the mix of your investment portfolio as you inch closer to the target date for retirement.

A target date fund will also offer a diverse mix of different asset classes as well as the individual securities within each asset category. Because they’re managed for you, this type of fund can be great to have in the background. However, it’s important to note that they don’t necessarily account for your individual risk tolerance. And, of course, target date funds can lose money if the stocks and bonds owned by the fund drop in value.

Now that we understand some of the strategies behind retirement asset allocation, let’s take a closer look at how investors can effectively distribute assets across their portfolios to strike a balance that works for them:

The first step before making any asset allocation decision should always be to talk to a trusted financial professional. If you’re already partnering with a financial planner, you’re off to a great start. Be sure to provide them with comprehensive details on all of your taxes, savings, employment, goals and expenses. This will help them design a customized plan that’s tailored to your circumstances.

To create this personalized retirement plan, you and your planner will also need to determine your time horizon and appetite for risk. For the former, you’ll want to ensure your investment strategy can sustain you beyond your life expectancy. Meanwhile, the latter will involve gauging your comfort level with hypothetical investment fluctuations. This information will be crucial in later steps and as you get closer to the age of retirement.

Estimating your retirement expenses is another pivotal step in determining your retirement asset allocation strategy. Take the time to examine your current expenditures and evaluate your anticipated retirement expenses. In addition to monthly costs for things like food, housing, transportation and health care costs, you’ll also need to factor in a rainy day fund in case of emergencies. Once you have this number, subtract your retirement income streams, such as Social Security or pensions, and the remaining sum will likely be what your investment portfolio needs to cover.

After you’ve drafted a retirement spending plan, you’ll need to work on creating a withdrawal strategy. This means evaluating how sustainable your intended spending habits will be. Start by considering the difference between your expenses and expected income sources, and don’t forget to factor in any Required Minimum Distributions. If you find you’re short on income, try withdrawing from taxable accounts first to leave deferred funds invested for longer. But be careful – this could bump you into a higher tax bracket.

Next, work with your financial advisor to determine your overall investment objective. With their guidance, you can develop a personalized retirement strategy that aligns with your lifestyle and goals. Consider how the factors we’ve talked about (i.e., risk tolerance, time horizon, retirement expenses and withdrawal rate) will impact your overall strategy. Your goals should reflect these considerations and tailor your asset allocation to personal preferences. However, you should also be willing to listen to your financial planner if they believe your portfolio is too conservative or aggressive for your goals.

As you and your financial planner begin to adjust and customize your asset allocation strategy, diversification is essential. The stock market is unpredictable; a sector could have booming growth one year and completely drop the next. Ensuring a diversity of different asset classes can help spread out performance to hopefully keep all your eggs from breaking in the same basket. But beyond a diverse range of classes, you’ll also want to diversify specific holdings within each asset category. This plays a crucial role in not only balancing your portfolio but ensuring it can weather market conditions.

Finally, continuous monitoring, reassessing goals and rebalancing your portfolio are paramount to planning for success. Check in with your financial planner regularly to assess your asset allocation and ensure your portfolio remains on track despite fluctuations. If a specific asset class had an enormous year of growth, it might be wise to reinvest those earnings into an underweighted category. As you get closer to retirement, you might also want to work with your planner to fine-tune your allocation based on age, changing risk tolerance or other adjustments to your personal goals. This proactive approach can help you preserve your wealth and help to optimize your retirement investment strategy for long-term success.

Here are a few best practices to remember when rebalancing your retirement asset allocation:

• Track your expenses carefully to see how much you’ll need and how much you can save
• Make sure you have the right mix of different asset classes to meet your comfort level
• Understand the risks of each asset class before you invest in them
• Don’t let sudden spikes or drops distract you from your investment strategy
• Partner with a financial advisor to develop a plan that can work in all types of market conditions