Saving for Retirement - Asset Allocation
You don’t need to be a great stock-picker or have a degree in investment banking to make money through investments. In fact, study after study has shown that the vast majority of the returns from any given portfolio result from the asset allocation of that portfolio. In other words, by simply choosing a nicely diversified mix of stocks, bonds, cash, and other investments, you can make an educated guess about the potential returns of your investments.
Your target asset allocation will change as you get older; “maturing” to a more conservative mix as you near retirement. For quarterlifers with 30 or more years until retirement, however, a very aggressive mix of large cap, small cap, and international stocks (or mutual funds/ETFs) is most appropriate for a retirement portfolio.
Personally, I like to keep my investments allocated like this:
There are tools available to help you decide on and maintain an asset allocation. For example, Quicken offers great tools for analyzing your asset allocation, and Janus provides a free asset allocation tool on the web.You can use asset allocation in combination with dollar cost averaging. If you invest $500 each month, for example, and use the allocation I described above - you would simply split your monthly investment like this:45% Large Cap stock
35% International stock
15% Small Cap stock
5% Cash
$225 into a large cap mutual fund or ETF
$175 into an international mutual fund or ETF
$75 into a small cap mutual fund or ETF
$25 into cash
Using asset allocation in combination with dollar cost averaging makes investing simple. You need only pick a few investments to begin with, and check on your portfolio once a year to maintain your target allocation. For example, if your large cap portion has grown significantly and now makes up 60% of your portfolio, but small caps only account for 5%, you would sell 10% of your large cap investments and use the proceeds to purchase additional small cap investments. Doing so causes you to sell assets that have performed well and buy additional shares of those that are lagging - automatically buying low and selling high!
Next time, we’ll take a closer look at what investments to consider for your retirement portfolio.
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| This entry was posted on Friday, October 13th, 2006 at 4:41 pm and is filed under "The Plan", Retirement, Investment, Asset Allocation. You may e-mail this post to a friend. You may print this page. You can leave a response, or trackback from your own site. | ||
October 13th, 2006 at 10:11 pm
In the early years you don’t have to sell/buy to do your annual rebalancing act. Just change the mix of your monthly savings to bring you back into balance. This will save you at least the cost of the buy/sell unit price spread.
Other points:
1. Your investment time frame is until you stop having investments (ie death), not retirement. There’s really no sensible reason to suddenly shift from investing in growth assets pre-retirement into a more conservative income-only asset mix when you retire. You will probably be invested for a long time after you retire.
2. Why have 5% into cash? Once you have a “emergency fund” (not necessarily a bank account, it could be a HELOC facility setup but not used) there’s no reason to include a very conservative, no growth asset in your allocation if your target is moderate-high growth.
Regards
http://enoughwealth.blogspot.com
October 15th, 2006 at 9:53 am
Your strategy of changing the monthly savings mix works, but has two major drawbacks. For one, it requires monthly attention. Most of the individuals I work with do not want to devote any additional time to financial matters - and annually rebalancing is a tested strategy that works with a minimal time investment. The second drawback is that rebalancing from time to time forces investors to move money from assets that have performed well to those that have performed poorly. Thus the investor automatically buys low and sells high - reducing risk and increasing returns over time.
I agree with you on point 1. As I mentioned before, the intended reader of this blog (25 or so and just starting out financially) may live to 90 or more years old. That means over 30 years in retirement. Clearly, a money market savings account is not an appropriate investment vehicle in retirement. However, it does make sense to move towards a more conservative mix on reaching retirement - both to preserve capital and provide current income in retirement.
As far as point 2, I like to hold a bit of cash in addition to emergency savings funds for a few reasons. Most importantly, having some liquidity gives the investor the ability to take advantage of investment opportunities (for example, purchasing a foreclosed property at sheriff’s sale) without selling performing assets. Second, it backs up the emergency reserve. I see so many individuals who have nothing in savings, despite planners frequent urging. Having some cash contributions in a Roth IRA safeguards the investor, in case they underfund or fail to hold emergency savings. A HELOC would be suitable in some cases - but most quarterlifers who own homes haven’t built up enough equity to make that option viable.