Editor’s Note: This story originally appeared on New retirement.
For most people, withdrawals from retirement savings are an important part of their retirement income.
To maximize your returns, but to make sure the money you need is there when you need it, you’ll want to match your asset allocation to your risk tolerance and adjust your allocation as your tolerance changes over time.
In an ideal world, you would have all your money in risk-free investments that offer high returns. However, it is impossible to reliably assume that you will have high returns or low risk and it is almost unheard of to have both, at least not at the same time.
Here’s what you need to know about asset allocation as you age.
What is asset allocation?
Asset allocation is how your assets (money) are allocated (invested) in different types of financial vehicles.
The most common asset allocation examples involve a combination of stocks, bonds, and cash, although other investments can and should be considered.
You want an asset allocation (investment mix) that suits your goals, risk tolerance, and time horizon for needing the money.
If you have a high tolerance for risk, you won’t need the money for a long period of time, and you have a goal of maximizing returns, then investments in stocks (or other asset classes with relatively high risk profiles) might be appropriate.
If you have a low tolerance for risk, need access to short-term money, and are aiming to preserve your capital while keeping pace with inflation, then you will want to have some cash, some in low-risk vehicles like bonds. and some in index funds to help you with inflation.
More risk when you are young, less as you get older
Conventional wisdom is to invest more risky when you are young and have long-term horizons to make up for losses. And invest much more conservatively when you’re older and depend on assets for retirement income.
In fact, a long-standing and widely accepted rule of thumb is to subtract your age from 100 and use that figure as the percentage of your portfolio that you should keep in stocks with the remaining funds in cash and bonds.
However, some financial planners now recommend that the rule now should subtract your age from 110 or even 120 to get the best percentage.
So if you are:
- 30, then you should have between 70% and 90% of your portfolio invested in stocks
- 40, then 60% to 80% in stocks
- 50, then 50% to 70%
- 60, then 40% to 60%
- 70, then 30% to 50%
- 80, then 20% to 40%
- 90, then 10% to 30%
With the New retirement planner you can now model a change in your future rate of return.
For example, if you are now 50 years old and modeling a 10% return on an account, you can now project your finances with a shift to a lower (or higher) rate of return when you turn 65 (or whatever age you choose ).
But wait, age isn’t everything!
Age is not necessarily the most important asset allocation factor for everyone.
In fact, the most important considerations for asset allocation are:
- How much money do you need?
- How much money do you want?
- What is the time frame for you want and need the money?
For example, let’s say you are 60 years old and have $ 800,000 in savings. You have determined that you will not need and will not want to spend more than $ 500,000 of your savings over its projected useful life (plus 10 years for good measure).
You could invest $ 500,000 in an asset allocation strategy based on your age with the remaining $ 300,000 invested for whatever other financial goals you have.
Bucket strategies are one way to determine the ideal asset allocation for you.
You determine your ideal asset allocation based on different types of money amounts.
Learn more about 3 different types of cube strategies.
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