Assess Your Asset Allocation for Retirement

Note: This article is part of Morningstar's 2021 Portfolio Tuneup special report. 

Like so many aspects of investing, the precisely right asset allocation--the mix of stocks and bonds that delivers the highest possible return with the least amount of risk over a given time frame--will be apparent only in hindsight.

Instead, investors have to rely on market history and a sober view of valuations for various asset classes to help guide their allocations. They can then fine-tune their allocations based on individual-specific factors, and monitor the portfolio's asset mix as they get closer to needing their money.

If you're setting your portfolio’s asset allocations for the first time or looking for a "reasonableness check" of your existing asset mix, here are some key steps to take.

Step 1: Look to outside guidance.
The gold standard for setting an asset allocation is to employ a financial advisor who can recommend an appropriate mix of assets given your own situation: your proximity to retirement, how you're doing on your retirement savings, and your own comfort level with volatility, among other factors. But if you don't have an advisor, or if you'd like to backstop an advisor's recommendations, you can rely on additional resources for asset allocation guidance.

Morningstar's Lifetime Allocation Indexes, informed by the research of Morningstar's Investment Management team, 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. The indexes also show suballocations for various asset classes--for example, they include percentage weightings in Treasury Inflation-Protected Securities and emerging-markets equities.

Target-date funds, which are designed as one-stop investments appropriate for a given retirement date, can provide an additional, professional view of appropriate asset allocations given different time horizons to retirement. It's valuable 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.

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. Others maintain more conservative allocations; if a fund limits volatility, the thinking goes, investors are more likely to stick with the program in good markets and bad.

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 the BlackRock LifePath Index Target-Date Fund Series and JP Morgan SmartRetirement. 

Step 2: Customize based on your own situation.
While off-the-shelf asset-allocation guidance, such as Morningstar's Lifetime Allocation Indexes and target-date vehicles, can help you assess your own in-retirement and pre-retirement asset allocation, they're just a few of many sources of information that you can turn to when setting your stock/bond/cash mix. Online retirement calculators can also be helpful. 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

Step 3: Keep it up to date.
Once you've set your asset allocation, it's important to periodically revisit your portfolio's actual asset allocation to make sure it's still on track. It's a given that some parts of your portfolio will perform better than others; periodically rebalancing back to your targets--both on an asset-class and intra-asset-class basis--can help reduce the volatility in your portfolio. Morningstar's Instant X-Ray--or the X-Ray functionality available in Portfolio Manager--can help you keep tabs on your portfolio's asset allocation. Periodically harvesting winning portions of your portfolio controls risk while also supplying cash you can use for living expenses in the years ahead.

Additionally, you'll need to revisit your own target stock/bond/cash mix as the years go by. For most investors, getting closer to their goal dates will necessitate a more conservative asset mix; as they get closer to spending what they've saved, they can't risk big fluctuations in the value of their nest eggs. That's why most glide paths for accumulators feature higher allocations to bonds and cash as retirement approaches. I've written extensively about the Bucket approach to retirement portfolio allocation, which helps you back into an asset allocation for retirement that takes into account your spending rate. I like the idea of customizing your in-retirement portfolio's asset allocation based on your own spending plan.

Individual circumstances can also change, so higher or lower allocations to various asset classes may be in order. For example, investors who find themselves well ahead of their savings targets owing to strong market performance over the past nine years may want to peel back on their equity allocations. In a similar vein, investors who are concerned about layoffs in their industries may do well to reduce their stock allocations--especially in their readily accessible taxable accounts--in case they need to prematurely tap their retirement nest eggs.