Asset allocation doesn't have to be daunting with this shortcut.
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By Rachel Haig | 04-05-10 | 06:00 AM | Email Article

If you're just starting out in investing, figuring out how much to invest in different asset classes can seem daunting. How much of your portfolio should be in stocks? Do you really need bonds if you're in your 20s? How should your allocation change as you get closer to retiring or reaching other savings goals? Luckily, there are tools to help.

Rachel Haig is assistant site editor for Morningstar.com.

Find Your Quick-and-Dirty Allocation
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 what different professionals would do, 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.

When Morningstar began  rating target-date fund series a few months ago, Vanguard and T. Rowe Price's offerings stood out as leading, but strategically different, choices. T. Rowe Price's target-date funds are a bit more aggressive, with heavier equity weightings.

Let's take a look at the allocations Vanguard and T. Rowe Price suggest for a 30-year-old. Assuming a retirement age of 65, we'll look at the 2045 target-date funds (of course, you could always look at earlier or later retirement dates if you wanted to see a slightly less or more aggressive allocation).

 Vanguard Target Retirement 2045 

 T. Rowe Price Retirement 2045 

These two target-date funds also use different underlying investments to populate their asset-allocation frameworks. Click here to view the Vanguard fund's top 25 holdings and here to view the top holdings in the T. Rowe fund. Vanguard's target-date fund focuses on index mutual funds (notice  Vanguard Total Stock Market Index  constitutes over 70% of the portfolio), while T. Rowe's uses more active funds. T. Rowe's target-date fund also holds a higher percentage of foreign stocks.

Once you have a general idea of what your allocation should be, you can use the investments of your choice to craft a portfolio that meets your preferences.

Test Out Your Allocation
You can see how small allocation adjustments are likely to affect your investment results using Morningstar's  Asset Allocator tool. (Asset Allocator is a benefit of Morningstar.com Premium Membership. Click here for a free 14-day Premium trial.)

The Asset Allocator tool calculates how likely you are to meet financial goals based on your current portfolio value, monthly investments, time horizon, and asset mix, and is useful for fine-tuning your allocation.

Continuing the example above, say I was to retire in 2045. How much would I need to invest each month to accumulate $1 million? Set the number of years to 35 and financial goal to $1,000,000, and enter your current savings and monthly investments to see your likelihood of meeting your goal.

The graph shows you the likelihood of accumulating certain amounts after 35 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 pre-set 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 saving a little more each month could have after 35 years.

Let's assume I currently have $20,000 saved, and will invest $1,000 each month. With the pre-set aggressive allocation, my chances look like this:

I have a 78% chance of reaching my goal. Is that certain enough? Personally, I'd rather have closer to a 90% chance of reaching my retirement goal, but the probability that is sufficient for you depends on your individual risk tolerance.

Play with your allocation and monthly contributions to get a better sense of how they both influence your investment growth. Click here to learn more about the asset allocator tool.

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Rachel Haig does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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Morningstar - 2010/04/05 - Just Starting Out? Find Your Allocation Baseline - <a href="http://www.morningstar.com/articles/author/1370-rachel-haig.aspx">Rachel Haig</a> 
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