Backing into Asset Allocation

Asset allocation is all about trying to control what can be controlled when it comes to investing. We know, for example, that we have no control over how markets react to a topsy-turvy world full of headlines. We can’t control what the Fed does with interest rates or when the economy goes into recession. And we know we can’t control a publicly traded company’s success or failure.

But we also know we can’t simply avoid investing in stocks just because they’re risky (and sometimes pretty scary…). So, we turn to asset allocation, or the process of finding our optimal blend of stocks, bonds, cash and “other” investment categories, to help us be productive investors in an uncertain world.

Now, asset allocation for younger folks is fairly straightforward. You’d typically complete some sort of questionnaire to determine how much risk you can tolerate, match your responses to a suggested mix of investments, and then focus on saving. It’s hard enough to save anyway, right?

This works for your 20’s, 30’s and 40’s when you’re mostly focused on accumulating retirement savings, but starts getting more complicated in your 50’s. There’s another step up in complexity in your late-50’s and early-60’s as the retirement concept starts seeming a little more real. Then asset allocation takes on a whole new meaning when you’re actually retired. It’s at this stage where we leave the hypothetical conversations about risk tolerance and spend more time talking about “risk capacity”, the risk you can afford to take and need to take for your long-term plans to be successful.

I mention all this because the economic and market situation is starting to look a little gloomy. Talk of potential recession abounds and we all remember just how nasty the last one was. If the next one is even close to that bad, how will that impact our retirement plans? Those living in retirement or those close to retirement are understandably nervous. Is it time to head for the hills until all this blows over? Hopefully (and obviously) the answer is a resounding no.  

Instead, it’s time to refocus on shoring up your asset allocation and even starting to think about the subject more broadly. What I mean is that instead of simply thinking about your allocation as a natural outcome of taking a risk tolerance questionnaire, you should also back into it based on the details of your own plan. This kind of stress testing will help give you the best shot at surviving a prolonged market downturn.

This is a detailed conversation, so my thinking is to lay out the concept in this post and then elaborate over the coming weeks. Here are some of the issues we’ll cover:

  • Stress testing your allocation using the Great Recession and a garden variety downturn as benchmarks. If stocks are down and market sentiment is too, but you still want to take that trip or buy the car you planned on, where should the money come from?
  • When and how to take profits when the market is up. Strange as it may sound, this is often a difficult subject for people.
  • Different methods for calculating your “emergency fund” needs during retirement.
  • How to use bonds as insulation against prolonged bouts of market volatility. Yes, bonds are boring, but they could save your tuchus if used correctly.
  • How to reconcile these areas with your current allocation. In other words, what to do if you realize your investment mix is all wrong.

Hopefully by the end of these next few weeks you’ll be better informed about how to get your asset allocation “retirement ready”. And remember that it’s not all doom and gloom, it’s appropriate planning that makes the difference.

Have questions? Ask me. I can help.

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