ARTICLE: Asset Allocation in the Golden Years

Key Points

• Why Asset Allocation Matters
• Conservative Retirement Portfolio
• Moderate Retirement Portfolio
• Aggressive Retirement Portfolio
• Next Step: Choosing Specific Investments
• Points to Remember

As you near retirement, it is important to estimate your future income needs and identify potential sources of retirement income. For most people, Social Security and pension income are not enough to get by. A portion of their retirement income must come from retirement savings and personal investments. Accordingly, once you transition into retirement, you will most likely need to shift the composition of your investment portfolio to accommodate your changing needs. Exactly how you choose to allocate your portfolio among different asset classes and investments will depend upon a number of factors, including your age, tolerance for risk, and the degree to which you rely on personal investments to fund your retirement.

Why Asset Allocation Matters

Asset allocation refers to the way in which you divide your portfolio among stock, bond, and cash investments. It is the single most important determinant of long-term returns for a given portfolio. Within each of these broad categories, there are many types and styles of investments, each with varying risk and growth characteristics. The asset classes you choose, and how you weight your investment in each, will largely determine your overall portfolio risk and long-term returns.

Following are three examples of typical retirement portfolio allocations that may shed some light on your own investment priorities. Keep in mind that these examples are hypothetical and your own circumstances will vary.¹

Conservative Retirement Portfolio¹

A conservative retirement portfolio is usually more "conservative" than a preretirement portfolio, where investors are less concerned with current income and are generally willing to take on greater risk. The allocation of a conservative retirement portfolio might be 30% cash, 50% bonds, and 20% stocks. Such a portfolio would have produced an average annual yield of 5.3% and an average total return of 8.7% during the 20 years ended December 31, 2007.² Such a portfolio might be suitable for older investors well into retirement or for those who have not accumulated significant savings for retirement and rely heavily on Social Security. A conservative allocation may also be appropriate for risk-averse investors. Note, however, that a stock component is still an important allocation if the portfolio is to grow and outpace inflation.

Different allocations may also affect how much of your portfolio principal you choose to withdraw each year. Generally, the more conservative the portfolio, the lesser the growth potential and the smaller the payout, although one's personal situation and risk comfort level will ultimately determine your withdrawal rate. Investors opting for a conservative allocation might consider a principal payout of between 3% and 5% each year, depending on the size of their portfolio and other individual circumstances.

Moderate Retirement Portfolio¹

A "moderate" retirement portfolio might consist of 20% cash, 40% bonds, and 40% stocks. This portfolio could suit a broad range of retirees of varied age and risk comfort levels. A moderate allocation may be suitable for investors who retire when eligible forfull Social Security benefits, for those who have accumulated a moderate retirement portfolio through IRAs and 401(k) plan participation, and who may supplement their retirement income through part-time work or by cashing in on home equity. Such a portfolio would have produced an average annual yield of 4.6% and average total return of 9.9% during the 20 years ended December 31, 2007.²

Investors choosing a moderate allocation might consider a principal payout of between 4% and 6% each year, depending on the size of their portfolio and other individual circumstances. Again, your withdrawal rate will depend on your personal situation.

Aggressive Retirement Portfolio¹

An "aggressive" retirement portfolio is best suited for investors with a high tolerance for risk and for those who retire early and anticipate many years in retirement. It also may be appropriate for those with a sizeable nest egg who do not rely heavily on Social Security or pensions as sources of retirement income.¹ The allocation of an aggressive retirement portfolio might be: 20% cash, 30% bonds, and 50% stocks. Such a portfolio would have produced an average annual yield of 4.1% and average total return of 10.2% during the 20 years ended December 31, 2007.²

Investors choosing an aggressive allocation might consider a principal payout of between 5% and 7% each year, depending on the size of their portfolio and other individual circumstances.

Next Step: Choosing Specific Investments

Once you've determined an appropriate asset allocation, you'll need to select specific investments for each asset class. The choice of investments within each class can be daunting. Stock investments, for instance, can be broken down into many subcategories based on company size, industry sector, or geographic location. And within each of these categories, there are thousands of companies and funds to choose from. A financial advisor can help you choose the individual investments that work best for you.

When selecting investments, be sure to avoid concentrating your assets in a particular company, sector, or investment type. Mutual funds can help you reduce this risk by diversifying among many different securities. They also carry the advantage of professional management and can be matched to fit specific asset classes.

¹These examples should not be construed as investment advice. See your financial advisor before making any decision as to your asset allocation.
²Source: Standard & Poor's. Stocks represented by the S&P 500 Index, a large-cap equity index representative of the U.S. stock market as a whole; bonds represented by the Lehman Brothers Long-Term Government Bond index; cash represented by 3-month Treasury bills. Past performance is no guarantee of future returns.

Points to Remember

• How you choose to allocate your portfolio among different asset classes and investments will depend on a number of factors including your age, your tolerance for risk, and the degree to which you will rely on your personal investments to fund your retirement.
• Asset allocation is the single most important determinant of long-term returns for a given portfolio. The asset classes you choose, and how you weight your investment in each, will largely determine your overall portfolio risk and long-term returns.
• A "conservative" retirement portfolio might be suitable for older investors well into retirement, for those who have not accumulated significant savings for retirement and/or rely heavily on Social Security, or for risk-averse investors.
• A "moderate" retirement allocation may be suitable for investors who retire when eligible for full Social Security benefits, who have accumulated a moderate retirement portfolio through IRAs and 401(k) plan participation, or who may supplement their retirement income through part-time work or by cashing in on home equity.
• An "aggressive" retirement portfolio may be best suited for investors with a high tolerance for risk, for those who retire early and anticipate many years in retirement, or a sizeable nest egg and will not rely heavily on Social Security or pensions as sources of retirement income.
• When selecting specific investments for each asset class, it's a good idea to diversify your holdings whenever possible to reduce portfolio risk.

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