Building retirement funds that give sufficient income to last for all retired years may involve creating a varied portfolio of investments. How assets are allocated is an important part of the retirement planning and saving process. What is asset allocation and what needs to be considered when saving for retirement?
What is Asset Allocation?
Asset allocation is the process that dictates where investments are made. So, for example, an investor may spread their investing across stocks, bonds, cash and annuities when putting together a retirement plan. Some will use all of these solutions; others will only use some of them.
Why is Asset Allocation Important for Retirement Planning?
Over the years cash is invested to build up a large enough retirement fund to live on, ideally for as long as the individual lives. This usually involves spreading risk across various types of investment to produce the necessary returns. Some investments are viewed as safe but may not produce fantastic results. Others are more prone to risk but may produce better returns.
Asset allocation for most people is a question of balancing this risk to produce the best results. Purely saving cash for retirement as a safe solution may not produce enough income to live on and inflation may devalue savings significantly. Investing solely in stocks may produce a phenomenal income if markets boom.
But, as many are experiencing at the moment, the volatility of investing in the stock markets makes this a riskier route to take. A good asset allocation plan may give a happy medium that balances risk and maximizes returns. To a certain extent the plan that is put in place will depend on the individual and a range of personal factors.
Factors That Influence Asset Allocation Strategies
No two individuals will necessarily have the same asset allocation needs. Some of the factors that play a part in this process include:
- How the individual views risk: Those that want to avoid risk may weight their asset allocation to safer investments such as cash savings, bonds and annuities. Those more open to taking risks may focus more on investment in stocks.
- When retirement savings begin: Those planning early for retirement may be able to take a different strategy than those needing to build an income later in life. Asset allocation strategies can vary according to how long the individual has to build funds.
Choosing the right way to allocate assets is important. Individuals should be comfortable with their strategy and should also be willing to change it over time as necessary.
Is a Mix of Steady Income and Variable Returns a Good Way of Allocating Assets?
Traditionally, many people have looked to build a core of safe investments that can be topped up by ones that may come with more risk. So, for example, the individual could use annuities, cash savings and bond investments to build a core retirement baseline. The aim here would be to give enough money to live on at a basic level.
The proportion of their investments that take on higher risk strategies could then be used to top up this base level. All being well, this can give “comfort” money. This isn’t needed for general living costs but adds some welcome income to the mix. This solution suits some, especially those that worry about losing their investment and the income they plan to build. It may not, however, suit those with higher income needs or those that wish to build more in savings for retirement.
Some may, as an alternative, prefer to invest early in life and to weight investments towards higher risk strategies to try and maximize returns. It is worth noting, however, that any asset allocation strategy should be checked out regularly as time passes. Individual needs and attitudes to risk will change as retirement approaches and plans often need to be changed over time.
Get Expert Asset Allocation Strategy Advice
Not everyone has the investment experience to set up their own asset allocation plan. This may be better done by a financial advisor or retirement planning specialist. These experts can assess what the individual needs and propose those solutions that may best suit them.
Before talking to a specialist, it may be worth checking projected income needs in retirement. Those that have already started saving may also find it useful to use a retirement savings calculator to get an estimate of how existing investments may deliver to these needs.
Carol Finch - Carol Finch is the Topic Editor for Retirement Planning, Budgeting, E-Commerce & Technical/Business Writing on Suite101.
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