Asset allocation: Creating the perfect mix
“Asset allocation” may sound like a complicated term, but its meaning is simple: It’s the practice of diversifying your portfolio with a mix of investment options. And it’s an essential part of getting the most from your retirement plan. Keep in mind that asset allocation and diversification do not guarantee a profit or protect against loss.
Your personal mix
"Asset allocation is absolutely critical," says Randy Long, managing principal at SageView Advisory Group in Irvine, CA. "A significant portion of an investor's total portfolio return is derived from the asset allocation."
Asset classes are categories of investment options. Each asset class has its own risk and performance characteristics. In general, asset classes with lower risk levels offer lower potential for growth. Likewise, asset classes with higher risk levels offer greater growth potential.
Mixing the various categories helps you develop an asset allocation in line with your risk tolerance.1 But how should you decide what mix is right for you? Consider the following:
Your savings timeframe
In general, the longer you have before retirement, the greater percentage you might choose to hold in higher-risk investment options, such as international equities.
The potential for inflation-beating growth is high with these investments, and the risk is lower, with plenty of time allowed for future returns to offset market downturns.
As retirement nears, however, you may shift a larger percentage of retirement funds to lower-risk categories, such as fixed income, to potentially help preserve what you've accumulated.
Your emotional response
A diversified asset allocation may help you feel more comfortable with your portfolio, even when the market shifts.
That's because you're better able to manage risk: With a mix of different investment options from various asset classes, you may not be impacted as much by changes to a single category.
Diverse asset allocation may also help you ride out market highs and lows, and resist the urge to speculate during market swings.
If the fear of market declines keeps you up at night, you may prefer to have a heavier mix of lower-risk investment options. If downturns don't bother you, and you’re decades from retirement, your allocation may be weighted toward higher-risk asset classes.
Whatever you do, be sure to stay on track.
Once you've established your asset allocation, review it at least annually, or as significant events occur. Be sure you’re comfortable with the mix of investments—and that your choices continue to be in line with your goals.
1 Keep in mind that all investment options are subject to investment risk, and it is possible for any investment option to lose value.