Understanding Retirement Asset Allocation

Understanding Retirement Asset Allocation

Asset Allocation: The Biggest Driver of Your Portfolio’s Return Over Time
Your Asset Allocation Will Be Based on Factors That Are Unique to You
Is It Time to Rebalance Your Portfolio?
Asset Allocation vs. Tax Allocation
6 Minutes to Read | 24 Minutes to Watch

Having an Understanding of Retirement Asset Allocation

When our Director of Investments Stephen Tuckwood, CFA joined Dean Barber on The Guided Retirement Show to discuss strategic investing through retirement, there was one thing in particular that he wanted to make very clear. Very early on in that conversation with Dean, Tuck said that asset allocation is the biggest driver of your portfolio’s return over time. We’re going to elaborate on why Tuck believes that so that you have a firm understanding of retirement asset allocation.

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What Is Asset Allocation?

When the topic of asset allocation comes up, what’s the first thing that comes to mind? For a lot of people, it’s trying to figure out what stocks they should have in their portfolio. But there is so much more to generating the greatest return for your portfolio throughout your lifetime than stock picking. And there’s so much more to having a successful retirement than making the right investments. It’s critical to have a forward-looking financial plan that considers taxes, estate planning, risk management, and your goals along with your investments.

Think of your personalized financial plan as a car. Each of those components that we just listed are essential so that your car consistently gets you from Point A to Point B without issue. Your investments are like the fuel that keeps your car running. That will make a lot more sense once you understand your retirement asset allocation, so let’s dive into the specifics of how to determine your asset allocation.

Your Asset Allocation Will Be Based on Factors That Are Unique to You

Again, the selection of stocks is just one piece of the pie for understanding your retirement asset allocation. As you’re determining how to build your portfolio, your retirement asset allocation is going to depend on your specific goals, risk tolerance, and your life expectancy. It isn’t advisable to determine your asset allocation based on your friend, family member, or colleague’s asset allocation because they won’t have the exact same goals, risk tolerance, and life expectancy.

Diversification Is Key

If your portfolio consists entirely of stocks, you could be under a lot of financial stress during a prolonged market downturn. It’s important to have diversification within the asset classes that you include in your portfolio. Including stocks, bonds, real estate, and cash equivalents in your portfolio can be a good starting point for reducing risk.

Diversification within Asset Classes

It’s also critical to have diversification within each of those asset classes as well. Let’s review some examples of diversification within equities and fixed income to help give you a better understanding of retirement asset allocation. Please understand, though, that these aren’t intended to be investment recommendations. Again, your goals and risk tolerance need to be factored into the equation before we can begin to look at your specific asset allocation.

Equities

Many people tend to think of stocks as a get-rich investment, and understandably so with their potential for high returns. You can invest in domestic stock options or expand your horizons and invest in international stocks. The sizes of company that you invest in vary as well, as there are small-cap, mid-cap, and large-cap companies that you can purchase stock in.

There are also different sectors of the stock market that you can invest in. For much of 2023, the technology sector was driving a substantial percentage of the S&P 500’s return. But there was no way of fully realizing that without looking at the performance of the cap-weighted S&P 500 compared to the equal-weighted S&P 500.

However, just because tech stocks were thriving for much of the year doesn’t mean that it was a good idea to make your portfolio tech heavy. If you overexposed yourself to tech stocks late last year, you may have missed opportunities that came in the broad-based market rally in the fourth quarter.

Fixed Income

While stocks are generally thought of as a get-rich investment, bonds are typically viewed as a stay-rich investment. However, think about what happened during the stock market downturn in 2022. Traditional bonds didn’t provide the safety net for investors that they had so many times before.

But there have still been opportunities in bonds as well. In case you missed it, Dean and AllianceBernstein’s David Mitchell examined some opportunities in municipal bonds earlier in 2024 on America’s Wealth Management Show. Shorter-term U.S. Treasury bond yields have also been more attractive while the U.S. Treasury yield curve has been inverted.

Whether it’s treasuries, bonds, or even CDs, make sure you understand their places within your retirement asset allocation. It’s really your broad asset allocation—the mixture of stocks and bonds in your portfolio—that will drive returns in the long run.

What’s Your Desired Asset Allocation?

So, what mixture of stocks and bonds do you want within your portfolio? 60% stocks and 40% bonds? 70% stocks and 30% bonds? Once again, your ideal asset allocation is going to depend on factors such as your goals and risk tolerance. However, one key aspect of understanding your retirement asset allocation is that you can’t take a set-it-and-forget-it approach with it.

Let’s say your desired asset allocation is 60/40. If you had that mixture at the beginning of this year, odds are that it won’t still be 60/40 by the middle or latter part of the year due to market fluctuations. This is where rebalancing comes in. It’s critical regularly review your portfolio’s performance and rebalance back to your target asset allocation when necessary.

How Much Risk Do You Want to Take in Your Portfolio?

Before we wrap up this article on understanding your retirement asset allocation, we want to touch a little bit more on risk. Younger investors who still have several years before they retire can afford to take more risk —if that is something they would like to do—by tilting a larger percentage of their portfolio toward stocks. They still have a paycheck that they can fall back on and have time before they retire to recover potential losses.

However, there’s a shift in mindset that needs to take place when you get closer to retirement. Preserving capital is key, as you’re getting closer and closer to no longer having a paycheck to fall back on. Having a more conservative asset allocation is something to keep top of mind as you’re planning for retirement.

And Then There’s Tax Allocation

While these considerations for asset allocation are very important, they sometimes can be ignored because people get too focused on tax allocation. And don’t get us wrong. Tax allocation is critical as well. It’s just pivotal to understand the differences between asset allocation and tax allocation as you’re planning for retirement.

As you’re determining your asset allocation, think about if you want to own your stocks and bonds in a taxable account or tax-deferred account. Anything that is kicking off taxable interest—such as bonds—should probably be in a tax-deferred account. Stocks, on the other hand, don’t cause taxation unless you sell them. So, make sure you have a good understanding of how your money is taxed in addition to your asset allocation throughout the retirement planning process.

Tax allocation and asset allocation are both topics that are mentioned in our Retirement Plan Checklist. It consists of a checklist of 30 yes-or-no questions that gauge your retirement readiness as age-based and date-based timelines that are comprised of several retirement considerations. Download your copy below.

Retirement Plan Checklist

Do You Think You Have a Good Understanding of Retirement Asset Allocation?

Just as Tuck did in his podcast, we want to reiterate that asset allocation is the biggest driver of your portfolio’s return over time. But how do you know you have the right asset allocation? That is one of many things during the retirement planning process that you don’t want to be doing guess work with. It’s critical to work with a team of professionals that gives you confidence that you’re doing the right things with your money, freedom from financial stress, and time to spend doing the things you love.

Our team of CFP® Professionals, CPAs, CFAs, estate planning specialists, and insurance specialists takes that to heart. As we’re building someone’s personalized financial plan, we’re putting their needs, wants, and wishes ahead of our own. So, if you have any questions about how to determine your asset allocation or the other key components of building your personalized financial plan, start a conversation with our team below.

Schedule a Meeting

There’s a lot that goes into understanding retirement asset allocation. If there’s one thing to take away from this article, it’s that your asset allocation is going to be unique to you. Our team is ready to help you get to the bottom of what your asset allocation should be and then regularly review it so that you don’t miss any planning opportunities as you approach and go through retirement.

Understanding Retirement Asset Allocation | Watch Guide

00:00 – Introduction
01:11 – What Is Asset Allocation?
04:36 – Keep Track of Your Accounts
06:28 – Marrying the Financial Plan and Investment Plan
09:33 – Let’s Talk About Rebalancing
12:18 – Tax Diversification and Asset LOCATION
17:54 – Direct Indexing
20:49 – Mutual Funds and ETFs
22:05 – What We Learned Today

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.