Is Your Retirement Portfolio's Asset Allocation on Track?

Most experts agree that your retirement portfolio's asset allocation--its mixture of stocks, bonds, and cash--will have the biggest impact on how much it grows, as well as its risk level.

Unfortunately, retirement savers seeking guidance on formulating an appropriate asset allocation may have a hard time knowing where to look. Sure, you could certainly do worse than adopting Jack Bogle's simple formula: 100 minus your age equals how much you should hold in stocks. But what if you want to come at the problem with a greater sense of precision? What if your personal situation puts you outside the norm--perhaps you're lucky enough to have saved far more than you'll ever need, or you've not saved enough and are playing catch-up? 

Thankfully, you don't have to fly blind. Here are some key information sources you can turn to when crafting your own asset-allocation plan. You may find it useful to sample an array of different opinions; you're apt to find a comforting convergence among various sources of guidance on this topic. 

How the Pros Do It
Target-date funds, which are designed as one-stop investments appropriate for your retirement date, are incredibly handy for do-it-yourself investors interested in building their own portfolios. Target-date funds offer a shortcut for helping to figure out how much is appropriate for someone like you to invest in different asset classes.

Looking at target-date fund holdings is like peering into what professional managers would do with your money. Once you have a sense of how different professionals would invest, you can take the parts you like and leave what you don't. It's important to take a look at target-date offerings from a couple of different fund companies--funds for the same retirement date can vary substantially based on glide-path philosophy and types of holdings.

 Morningstar's Target-Date Fund Series reports do a good job of summarizing the glide paths, as well as the pros and cons, of various target-date series. Some target-date programs maintain very high equity allocations before and even during retirement, a stance informed by the view that longevity risk--that is, the chance that you'll outlive your assets--should outweigh concerns about short-term fluctuations in an investor's principal. 

Funds in T. Rowe Price's Retirement series, for example, generally have above-average equity weightings relative to other target-date funds in that same age band. Meanwhile, other target-date fund series have steered a more conservative, bond- and cash-heavy course, in the view that big stock weightings add more volatility than most people need or want, which in turn could lead to panic-induced selling amid stock market downturns. American Century's LIVESTRONG series, for example, is generally lighter on equities during the accumulation phase than most target-date series, though its portfolios maintain relatively higher equity weightings for those nearing or in retirement. Thus, sampling an array of opinions from target-date funds geared toward investors in your same age band can help get you in the right ballpark; Morningstar analysts' favorite series are those from T. Rowe Price, American Funds, JP Morgan, and Vanguard. 

Morningstar's Lifetime Allocation Indexes, informed by the research of Ibbotson Associates, provide another vantage point on the asset-allocation question. In addition to providing separate asset allocations for various time horizons, the indexes also allow customization by risk profile for each age band: conservative, moderate, and aggressive. In addition, the indexes also show suballocations for various asset classes--they recommend percentage weightings in Treasury Inflation-Protected Securities and commodities, for example.

 The Customized View 
 Morningstar's Asset Allocator tool provides another, goal-based view of asset allocation, harnessing your own portfolio information if you've saved one on Morningstar.com. The tool calculates how likely you are to meet financial goals based on your current portfolio value, monthly investments, time horizon, and asset mix.

For example, how much would someone retiring in 2045 need to invest each month to accumulate $1 million? Set the number of years to 34 and financial goal to $1,000,000, and enter your current savings and monthly investments.

The graph shows you the likelihood of accumulating certain amounts after 34 years--see the key on the left. Click and drag the portfolio asset mix bar on the bottom left (or click on one of the preset allocations) to see how altering your asset mix would affect your likelihood of meeting your goal. While you're at it, adjust your monthly investment amount to see the effect of saving a little more each month.

If it looks like your current portfolio will fall short of your goal for a lump sum or annual income in retirement, play with your allocation and monthly contributions to get a better sense of how they both influence your investment growth.

Fine-Tuning
While off-the-shelf asset-allocation guidance, such as target-date vehicles and Morningstar's Asset Allocator tool, can help you assess your own in-retirement and preretirement asset allocation, it's just one of many sources of information that you can turn to when setting your stock/bond/cash mix. Whether you use a financial advisor or manage your investment portfolio on your own, it's crucial to consider your personal set of circumstances to arrive at an asset-allocation framework that truly fits your needs. Among the factors that could affect your in- and pre-retirement asset allocation are your desire to leave a legacy, other sources of income you can rely on in retirement, the longevity history of your own family, your savings rate, and the size of your retirement portfolio.

Here are some other questions to consider when calibrating your own asset allocation:

Are you expecting other sources of income during retirement, such as a pension?

Yes: More equities

No: Fewer equities

Does longevity run in your family?

Yes: More equities

No: Fewer equities

Are you expecting to need a fairly high level of income during retirement?

Yes: More equities

No: Fewer equities

Have you already accumulated a large nest egg?

Yes: Fewer equities

No: More equities

Is your savings rate high?

Yes: Fewer equities

No: More equities

Is there a chance that you'll need to tap your assets for some other goal prior to retirement?

Yes: Fewer equities

No: More equities

Do you want to leave assets behind for your children or other loved ones?

Yes: More equities

No: Fewer equities

If still working, are you in a very stable career with little chance of income disruption?

Yes: More equities

No: Fewer equities

This article takes a closer look at many of the above issues to help you customize an asset-allocation framework based on your own situation.

A version of this appeared Oct. 18, 2011.

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