To be successful at investing, some people think they need to “get in on the ground floor” of the next “big thing.” However, instead of waiting for that one “hot” stock that may never come along, consider creating an asset allocation – a mix of investments – that’s appropriate for your needs, goals and risk tolerance.
But once you have such a mix, should you keep it intact forever, or will you need to make some changes? And if so, when?
To begin with, why is asset allocation important? Different types of investments – growth stocks, income-producing stocks, international stocks, bonds, government securities, real estate investment trusts and so on – have unique characteristics, so they rarely rise or fall at the same time. Thus, owning a mix of investments can help reduce the forces of market volatility. (Keep in mind, though, that allocation does not ensure a profit or protect against loss.) Your particular mix will depend on your investment time horizon, comfort with risk, and financial goals.
When you are young, and starting out in your career, you may want your asset allocation to be more heavily weighted toward stocks and stock-based investments. Stock investments historically have provided the greatest returns over the long term – although, as you’ve probably heard, past performance can’t guarantee future results – and you will need this growth potential to help achieve your long-term goals, such as a comfortable retirement. Stocks also carry a greater degree of investment risk, including the risk of losing principal, but when you have many years to invest, you have time to potentially overcome the inevitable short-term declines.
Once you reach the middle-to-later stages of your career, you may have achieved some of your goals that required wealth accumulation, such as sending your children to college. However, what is likely your biggest long-term goal – retirement – still awaits you, so you may not want to scale back too much on your stocks and other growth-oriented investments. Nonetheless, including an allocation to bonds can help to reduce some of the volatility of the stock portion of your portfolio.
Now, fast forward to just a few years before you retire. At this point, you may want to lower your overall risk level, because, with retirement looming, you don’t have much time to bounce back from downturns – and you don’t want to start withdrawing from your retirement accounts when your portfolio is already going down. So, now may be the time to add bonds and other fixed-income investments. Again, though, you still need some growth opportunities from your investments – after all, you could be retired for two, or even three decades.
Finally, you’re retired. At this point, you should adjust your asset allocation to include enough income-producing investments – bonds, certificates of deposit, perhaps dividend-paying stocks – to help you enjoy the retirement lifestyle you’ve envisioned. Yet, you can’t forget that the cost of living will likely rise throughout your retirement. In fact, at a modest 3 percent inflation rate, the price of goods will more than double after 25 years. So even during retirement, you need your portfolio to provide some growth potential to help you avoid losing purchasing power.
By being aware of your asset allocation, and by making timely adjustments as necessary, you can provide yourself with the opportunities for growth and income that you will need throughout your life.
The views and opinions expressed in the column are those of the author and do not necessarily reflect the views of Hill Now.