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Investing Specialists

Is Your Retirement Portfolio's Asset Allocation on Track?

Some guidance on setting--and not forgetting--your portfolio's stock/bond/cash mix.

Note: This article is part of Morningstar's January 2016 5-Step Retirement Portfolio Assessment Week special report. An earlier version of this article appeared on Jan. 27, 2015.

Investors are often coached on the importance of finding the "right" asset allocation. To be sure, a portfolio's mixture of stocks, bonds, and cash will tend to have a bigger impact on its performance than smaller-bore factors such as security selection.

However, asset allocation is, out of necessity, an imprecise science; the "right" asset allocation for a given time frame--the one that delivered the highest return with the least amount of volatility--will only be apparent in hindsight.

Instead, investors have to rely on market history and a sober view of valuations for various asset classes to help guide their allocations. Those aren't tasks that many individual investors have the time or inclination to tackle, but there are some valuable guideposts they can use to ensure that their asset allocations are in the right general vicinity. They can then fine-tune their allocations based on individual-specific factors.

For investors who are setting their asset allocations for the first time or looking for a "reasonableness check" of their existing asset mixes, here are some key steps to take.

Step 1: Take It From the Pros
Target-date funds, which are designed as one-stop investments appropriate for a given retirement date, are incredibly handy for do-it-yourself investors interested in building their own portfolios.

Looking at target-date fund holdings is like peering into what professional managers would do with your money. Once you have a sense of how different professionals would invest, you can take the parts you like and leave what you don't. It's important to take a look at target-date offerings from a couple of different fund companies--funds for the same retirement date can vary substantially based on glide-path philosophy and types of holdings.

 Morningstar's Target-Date Fund Series reports do a good job of summarizing the glide paths, as well as the pros and cons, of various target-date series. Some target-date programs maintain very high equity allocations before and even during retirement, a stance informed by the view that longevity risk--that is, the chance that you'll outlive your assets--should outweigh concerns about short-term fluctuations in an investor's principal. 

Funds in T. Rowe Price's Retirement series, for example, generally have above-average equity weightings relative to other target-date funds in that same age band. Meanwhile, other target-date fund series have steered a more conservative, bond- and cash-heavy course, in the view that big stock weightings add more volatility than most people need or want, which in turn could lead to panic-induced selling amid stock market downturns. American Century's One Choice Target-Date Fund Series, for example, is generally lighter on equities during the accumulation phase than most target-date series, though its portfolios maintain relatively higher equity weightings for those nearing or in retirement. Thus, sampling an array of opinions from target-date funds geared toward investors in your same age band can help get you in the right ballpark; Morningstar analysts' favorite series are those from T. Rowe Price and Vanguard.

Morningstar's Lifetime Allocation Indexes, informed by research from Morningstar Investment Management, provide another vantage point on the asset-allocation question. In addition to providing separate asset allocations for various time horizons, the indexes also allow customization by risk profile for each age band: conservative, moderate, and aggressive. In addition, the indexes also show suballocations for various asset classes--they recommend percentage weightings in Treasury Inflation-Protected Securities and commodities, for example.

Next Up: Fine-Tuning
While off-the-shelf asset-allocation guidance, such as target-date vehicles and Morningstar's Lifetime Allocation Indexes, can help you assess your own in-retirement and pre-retirement asset allocations, it's just one of many sources of information that you can turn to when setting your stock/bond/cash mix. Whether you use a financial advisor or manage your investment portfolio on your own, it's crucial to consider your personal set of circumstances to arrive at an asset-allocation framework that truly fits your needs. Among the factors that could affect your in- and pre-retirement asset allocations are your desire to leave a legacy, other sources of income you can rely on in retirement, the longevity history of your own family, your savings rate, and the size of your retirement portfolio. This article does a deeper dive into knowing whether your plan needs a higher degree of customization than would be the case for investors with more generic financial situations.

Here are some other questions to consider when calibrating your own asset allocation:

Are you expecting other sources of income during retirement, such as a pension?
Yes: More equities
No: Fewer equities

Does longevity run in your family?
Yes: More equities
No: Fewer equities

Are you expecting to need a fairly high level of income during retirement?
Yes: More equities
No: Fewer equities

Have you already accumulated a large nest egg?
Yes: Fewer equities
No: More equities

Is your savings rate high?
Yes: Fewer equities
No: More equities

Is there a chance that you'll need to tap your assets for some other goal prior to retirement?
Yes: Fewer equities
No: More equities

Do you want to leave assets behind for your children or other loved ones?
Yes: More equities
No: Fewer equities

If still working, are you in a very stable career with little chance of income disruption?
Yes: More equities
No: Fewer equities

Finally: Keep It Up to Date
Once you've set your asset allocation, it's important to periodically revisit your portfolio's actual asset allocation to make sure it's still on track. It's a given that some parts of your portfolio will perform better than others; periodically rebalancing back to your targets can help reduce the volatility in your portfolio. (This article discusses how to determine whether it's time to rebalance, while this one delves into some mistakes that would-be rebalancers should avoid.) 

Additionally, you'll need to revisit your own target stock/bond/cash mix as the years go by. For most investors, getting closer to their goal dates will necessitate a more conservative asset mix; as they get closer to spending what they've saved, they can't risk big fluctuations in the value of their nest eggs. That's why most glide paths for accumulators feature higher allocations to bonds and cash as retirement approaches.

Individual circumstances can also change, so higher or lower allocations to various asset classes may be in order. For example, investors who find themselves well ahead of their savings targets owing to strong market performance over the past five years may want to peel back on their equity allocations. In a similar vein, investors who are concerned about layoffs in their industries may do well to reduce their stock allocations--especially in their readily accessible taxable accounts--in case they need to prematurely tap their retirement nest eggs.