Allocation Decisions

Before you can determine how best to distribute your asset allocation, you should first determine your investment goals. Are you hoping to build assets for retirement, to provide for your child's college education or to purchase a new home?

Some things to remember when thinking about your investment goals include the kind and amount of risk you are willing to tolerate, and the amount of time you have to let your investments grow, also called the time horizon.

Generally, the longer your time horizon the more aggressive you can be with your investments. As your time horizon begins to shrink and you approach your goal, it is prudent to become more conservative in your investment planning.

Risk tolerance is the second important factor in your financial goal planning. Some investors with a high risk tolerance are willing to sit comfortably while the market value of their holdings falls. They consider downward market fluctuations to be just another part of investing. Others, however, have a lower risk tolerance and can become quite anxious when they see the price of their assets declining.

Your emotional response to market downturns must be considered before you determine your asset allocation.

The amount of money you have available to invest can also influence your allocation decision. If you have trouble making ends meet, you might be unable to take too much risk with your investments. On the other hand, if your personal finances are on a sound footing, you might be able to tolerate the price fluctuations that will occur in a higher-risk portfolio.

No two investors have identical goals, time horizons, risk tolerance or financial conditions.
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Sample Retirement Savings Portfolios

The following examples demonstrate how different personalities, conditions and goals might affect asset allocation decisions.

Joe Weaver is a 26-year-old graphic designer, recently hired in a printing company. Because of Joe's age, his time horizon is quite long, and therefore he should consider an asset allocation that can withstand more risk. An allocation including a large amount of stocks would be a good idea for Joe because over time, stocks have provided better returns than the other primary asset classes and have served as a better hedge against inflation. Additionally, the longer the time horizon, the more time the investor has to weather the market's ups and downs.

However, Joe's risk tolerance would not allow him to invest totally in stocks, as downward market fluctuations tend to make him anxious about his investments. One possible asset allocation to meet Joe's needs might be 85 percent stocks and 15 percent bonds.

Jill Gustafson is a research assistant for a marketing firm. She is 58 and has done most of her retirement investing through her company's 401(k) plan. Her current allocation includes about 85 percent in stocks and the remaining 15 percent in bonds. Jill is considering retiring in a few years and is contemplating changing her allocation.

In Jill's case, she might want to consider moving some of her funds out of the higher risk stocks and into more stable investments like bonds. The return will most likely be lower than what she has experienced in recent years, but the risk is also much lower and could offer her peace of mind to know her retirement nest egg is safe.

One possible asset allocation plan for Jill might be 50 percent stocks and 50 percent bonds.

Robert Vasquez recently turned 64 and retired from the business he has owned and operated for 40 years. Robert opened an Individual Retirement Account years ago, and although he contributed to it regularly, he paid very little attention to it.

Robert needs money now to supplement his Social Security benefits.

It would seem prudent for Robert to consider using his IRA funds for an asset allocation equal to 80 percent bonds and 20 percent stocks. With this type of asset, he can have access to highly liquid bonds and still take advantage of the higher earning stocks.
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Re-Balancing Your Portfolio

Your initial asset allocation should be determined after some careful thought. But remember that whatever formula you decide upon, it is not something you should just forget about and keep forever.

It is a good idea to reconsider your allocation periodically or whenever you feel your investment goals have changed or the initial allocation amounts have shifted. Re-balancing your portfolio is a responsibility that all informed investors should take seriously.

Suppose for example that your initial asset allocation was 80 percent stocks and 20 percent bonds. But higher-earning market conditions over the past two or three years have pushed the stock portion of your portfolio to nearly 90 percent. This puts you at greater risk than you initially decided upon.

Keeping an eye on your portfolio's asset allocation ensures that your portfolio is closely aligned with your investment goals. Without proper upkeep of your portfolio, you subject yourself to more risk than you are comfortable with. Or, you limit the amount of returns you might be earning.

To rebalance your asset allocation you may have to sell some investments and reinvest in others, add new money to your funds or redirect dividend distributions from investments that exceed their recommended percentage to investments that are below their target allocation.

It's also important to rebalance your allocations as you move from aggressive investments (primarily stocks) in your younger years to more conservative investments (primarily bonds) as you near retirement.
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