How to Find Your Ideal Asset Allocation

Updated: August 4, 2022

Created in Collaboration with Kiplinger.

Market risk can be less of a concern when stocks are going up. That changed in early March 2020 when stocks declined at the fastest rate in bear market history.¹ Swift shifts like these give investors a reason to revisit their asset allocation – the percentage of stocks, bonds, and cash they hold in their investment portfolio.

“Asset allocation is probably the most important investment decision you are going to make,” says Mari Adam, CFP^®, a financial planner in Florida. “Asset allocation is deciding how much of your portfolio should be in stable income-producing investments, like bonds, and how much in growth-oriented investments, like stocks. It’s really the bedrock of portfolio design.”

The appropriate asset allocation can vary greatly between investors – even among those who are the same age. It’s important to work closely with your financial professional to find the right mix of investments, from the most aggressive to the safest, that will provide the growth you need to help meet your financial goals in retirement.

Consider these five questions as you and your financial professional determine how to achieve your ideal investment mix.

1. What drives the decision?

 

There are two major factors involved in finding the appropriate asset allocation for you:

• Time: How many years can you keep the money invested before you need to access it? Typically, the more time you can invest, the more your portfolio should be weighted in stocks that tend to be more volatile over the short term but outperform other asset classes over the long term.
• Risk tolerance: Are you comfortable with day-to-day stock market swings? If not, adding bonds to your portfolio can offer some stability – along with income and some potential growth.

2. Is there a standard formula?

 

There is no one-size-fits-all asset allocation. One 55-year-old pre-retiree might be more risk-averse than another. A 60-year-old who plans to work another five years may need less cash than a peer who is retiring next month and will soon start taking distributions from their portfolio. Your ideal allocation is the one that’s tailored to you.

As a guide, the traditionally recommended allocation has long been 60% stocks and 40% bonds. However, with today’s low return on bonds, some financial professionals suggest a new standard: 75% stocks and 25% bonds. But financial planner Mari acknowledges that can be more risk than many investors are prepared to take. If investors have too much exposure to stocks, they may be more likely to sell them at an inopportune time – when shares plunge, she points out.

Source: Stock Allocation Rules. Investopedia, July 11, 2022.

3. What’s my target?

 

First, consider your investment time horizon. This period can stretch over decades if you’re saving for retirement. And even if you’re nearing or in retirement, your portfolio may need to support you for many years, so you could benefit from the growth that stocks can provide to keep up with inflation.

Second, retirees also can use anticipated cash-flow needs to help develop their asset allocation framework. For example, assets that won’t be needed for another decade could be invested in stocks. Savings needed for the middle years of retirement could be invested in high-quality bonds. And assets required sooner – say in five years – could be allocated to safer, short-term bond funds or cash-like investments that are more liquid such as money market accounts.

Finally, consider taking an online risk assessment to determine how much investment risk you’re comfortable with. Or, gauge your risk tolerance by your reaction to market losses during the 2008 financial crisis. “Were you checking your portfolio all the time? Were you re-evaluating it?” asks Rand Spero, CFP^®, a financial planner in Massachusetts. “You were 14 years younger then. How else has your attitude about risk changed in 14 years?” Spero asks. Perspectives should be revisited over time.

4. How can I minimize investment risk?

 

Another way to help reduce risk is by diversifying the types of stocks and bonds you own. This way, if some types of investments falter, the loss may be offset by gains among other investments.

For example, a stock portfolio can include shares in companies that are big and small, domestic and international. You can also add growth stocks (companies with rapidly growing earnings and sales) and value stocks (shares that are inexpensive in relation to the companies’ earnings and sales).

A diversified bond portfolio may include U.S. Treasuries, corporate and municipal bonds, foreign and domestic bonds, and short- to intermediate-term bonds.

5. When should I review and rebalance my portfolio?

 

It’s a good idea to meet with your financial professional to revisit your asset allocation at least once a year to make sure it hasn’t drifted too far. For example, if stocks do well for a sustained period, you might discover your original portfolio with 50% stocks and 50% bonds is now at 60% stocks and 40% bonds.

With your financial professional’s help, your portfolio can be adjusted appropriately. A common guideline is to consider rebalancing your holdings if any asset class has veered five percentage points or more off its original allocation.² By rebalancing, you sell securities that went up in value and put the proceeds into those that fell or stayed flat to return to your desired allocation.

But rebalancing during a volatile market that swings widely over a few days can be a challenge. For instance, during a single week in March 2020, the S&P 500^® Index³ went down 7.6% one day and up 9.3% another day, before falling 12% a few days later.⁴ Instead of trying to keep up with rebalancing on a daily basis, choose one day each year – perhaps early in the new year or your birthday – to review your asset allocation and rebalance your portfolio if needed.

Adapting to Any Market Reality

 

Asset allocation and diversification are fundamental to managing portfolio risk. Your financial professional can help you create and refine the investment mix that makes sense for your risk tolerance, time horizon, and retirement goals.