Almost one-third of investors say that none of their retirement savings is going into stocks, according to a recent online poll. Some of the respondents cited the current economic climate as a reason for the dearth of equities.
It can be difficult to avoid emotional reactions to changes in the market, but a carefully considered long-term asset allocation strategy may help your retirement portfolio better endure volatility. After all, research suggests that over 90% of a portfolio’s performance is a direct result of how its assets are allocated.
Asset allocation is the process of dividing your investment dollars among asset classes that often behave differently in different market cycles. An asset allocation strategy may help reduce your exposure to risk and possibly enhance your portfolio’s performance over the long term.
Consider the Factors
The appropriate percentage of equities, debt instruments, and cash equivalents in your portfolio will depend on some key factors:
- Financial goals. Are you saving for retirement? Your children’s education? A second home?
- Time horizon. When will you need the money: 10, 20, 30 years? How old are your children? When do you want to retire?
- Risk tolerance. How comfortable are you with exposure to risk? Do market fluctuations make you nervous? Are you young enough to recover from losses?
These three variables make the appropriate allocation potentially different for everyone. A 55-year-old nearing retirement will have different needs than a 40-year-old with two children preparing for college.
Moreover, investments can be diversified within each asset class to further reduce a portfolio’s exposure to risk. For example, the stock portion of a portfolio can be divided into small/large cap, value/growth, and other categories.
Asset allocation and diversification do not guarantee against investment loss; they are methods used to help manage investment risk. The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.
After developing an appropriate asset allocation strategy, it is important to periodically revisit and revise your strategy. Over time, outperforming assets may grow and skew your percentages. You may need to rebalance your portfolio in order to maintain your percentages. Also, you may need to make changes to your allocation as you near retirement or as your investing goals change. Be aware, however, that rebalancing may result in taxes owed.
Although current market conditions may warrant re-examining your asset allocation, be careful not to abandon a carefully considered strategy in favor of an emotional reaction.