IMPORTANCE OF ASSET ALLOCATION
It's hard to overstate the importance of actively managing the assets in your retirement portfolio. Past economic events have highlighted the importance of managing your portfolio and choosing a wide variety of investments to help protect your retirement savings from risk.
Take time once or twice a year to make decisions about your retirement goals and determine how much risk you're willing to take on. By paying attention to the variety of investments in your portfolio, you can take better advantage of growth potential and help reduce losses.
Three important things to consider:
- Asset allocation
- Your target asset mix
- Asset drift
Working with an advisor can also help you keep a clear view of how your portfolio is performing in relation to your goals, so you can make the necessary adjustments.
Asset Allocation Makes a Difference
Asset allocation is the process of developing a diversified portfolio by choosing investments from a variety of asset classes. The graph illustrates the idea by showing a portfolio divided into equal asset classes: stocks, bonds, and treasury bills (cash).
Different asset classes have different characteristics, so they respond differently when the market changes. When choosing your investments, consider your financial goals and needs, how long you plan to remain invested in the market, and how much risk you're willing to take on. Participation in an asset allocation program or a rebalancing program does not guarantee performance or protect against loss.
Maintain Your Target Asset Mix
Your target asset mix determines the balance between risk and growth in your portfolio. The right mix will help you meet your financial goals for retirement while maintaining a comfortable risk level. A mix of 60% stocks and 40% bonds, for example, would be considered more aggressive than 40% stocks and 60% bonds.
But, your asset mix will shift over time because asset classes grow at different rates in different markets. If stocks accelerate, you might end up with more of your assets in stocks. This could expose you to more risk than you want. Or stocks could slow down, leaving you more heavily invested in bonds, which might limit the growth potential in your portfolio.
When you rebalance, you choose different investments to adjust the amount of assets you have invested in various classes. This helps maintain your preferred balance between growth and risk.
Remember to Account for Asset Drift
Between 1990 and 2005 the stocks in the hypothetical portfolio above grew to account for 75% of its assets. Poor stock market performance in subsequent years brought the stock allocation down to 72% by 2010.
This is a natural progression based on market events, and it's referred to as asset drift. In this case, the resulting asset mix is drastically different from the original 50/50 mix chosen in 1990. And the portfolio is far riskier as a result. By rebalancing your portfolio annually, you can correct any drift that takes place before it pulls you too far off target.
Employ a Strategic Approach
Fluctuations in the market can be alarming, but a well-planned strategy carried out over time is more reliable than making snap decisions in reaction to market changes. There is no substitute for maintaining your plan with the help of a trusted advisor.
By staying in touch with your portfolio, you can make timely decisions that help you avoid loss and get the most out of the growth potential of your assets.