For most people, withdrawals from retirement savings are an important part of their retirement income. To maximize your returns, but insure that the money you need is there when you need it, you will want to match your asset allocation to your risk tolerance and adjust your allocation as your tolerance changes over time.
In an ideal world, you would have all of your money in risk-free investments that deliver high returns. However, it is impossible to reliably assume that you will have either high returns or low risk and it is almost unheard of to have both — at least not at the same time.
Asset allocation is how your assets (money) are allocated (invested) into different types of financial vehicles.
The most common asset allocation examples involve a mix of stocks, bonds, and cash, though other investments can and should be considered.
You want an asset allocation (mix of investments) that is suited to your goals, tolerance for risk, and time horizon for needing the money.
If you have a high tolerance for risk, won’t need the money for a long period of time and have a goal for maximizing returns, then investments in stocks (or other asset classes with relatively high risk profiles) might be appropriate.
If you have a low tolerance for risk, need access to money in the short term, and have the goal of preserving your capital while keeping pace with inflation, then you will want some money held in cash, some in low risk vehicles like bonds and some in index funds to help you with inflation.
The conventional wisdom is to invest with more risk when you are young and have long time horizons to make up for any losses. And, invest far more conservatively when you are older and relying on the assets for retirement income.
In fact, a long-held and widely accepted rule of thumb is to subtract your age from 100 and that is the percentage of your portfolio that you should keep in stocks with the remaining funds in cash and bonds.
However, some financial planners are now recommending that the rule should now be subtracting your age from 110 or even 120.
So if you are:
- 30, then you should have 70–90% of your portfolio invested in stocks
- 40, then 60–80% in stocks
- 50, then 50–70%
- 60, then 40–60%
- 70, then 30–50%
- 80, then 20–40%
- 90, then 10–30%
NEW, Model a Change to Future Rates of Return: With the NewRetirement Planner you can now model a change to your future rate of return. For example, if you are 50 now and are modeling a 10% return on an account, you can now project your finances with a switch to a lower (or higher) rate of return when you turn 65 (or whatever age you choose).
Age isn’t necessarily the most important asset allocation factor for everyone.
In fact, the most important considerations for asset allocation are: 1) What amount of money do you need? 2) What amount of money do you want? And, 3) What is the time frame for you to want and need the money?
For example, let’s say you are 60 and you have $800,000 in savings. You have determined that you will need and want to spend no more than $500,000 of your savings through your projected longevity (plus 10 years for good measure).
You could invest $500,000 in an asset allocation strategy based on your age with the remaining $300,000 invested for whatever other financial goals you have.
Bucket strategies are one way to determine the ideal asset allocation for you.
You determine your ideal asset allocation based on different types of buckets of money.
Learn more about 3 different kinds of bucket strategies.
The rate of return you project on your money impacts your future retirement security.
A small difference in your assumed rate of return can have a big impact on how much you think you need to save for retirement and how much you can withdraw for retirement income.
So, it is important to try to get your projections right. See What Rates of Return Should You Use for Retirement Planning to learn more about possible rates to use.
