Asset Allocation

Next let’s look at your asset allocation, which is the percentage of your investment portfolio allocated to various asset classes such as cash, bonds, and equities. Before moving on, please read our Asset Allocation primer under the Resources tab to get up to speed on historical and expected returns for the major asset classes. Asset allocation is one of the most important and interesting aspects of retirement planning. And as a disclaimer, this information is provided for educational purposes, so I cannot offer exact asset allocation suggestions for every financial situation. However, I will provide you with a framework for determining your asset allocation. It’s also important to point out that these percentages are for assets in your retirement and brokerage accounts and excludes cash you have in an emergency fund or cash for a known expense such as a home renovation project or a new car. 

Asset Allocation Recommendations:

 asset allocation

Expect to retire in more than 10 years

With more than 10 years until you expect to retire, I recommend an equity allocation of 90-100%, with 55-60% invested in U.S. Equities and 35-40% in International Equities. With the remaining 0-10%, I recommend keeping cash in a high yield savings account where you can typically earn 1-1.25%. The reason for the high allocation to equities is because yields for U.S. Government and Corporate bonds are at or near all-time lows as shown in the following charts. Over a 10+ year time horizon you should expect to generate higher returns by investing in equities. If you have a mortgage with a rate above 2.5%, then you are guaranteed to generate a higher guaranteed return simply by paying down your mortgage. While you may want to allocate more than 10% of your portfolio to cash, just realize that this is likely not the best financial decision. 

5-Year and 10-Year Treasuries are near all-time lows

 asset allocation

Corporate bond yields are at all-time lows

 asset allocation

Expect to retire in 5-10 years

In this time frame I still recommend a high equity allocation closer to 80-90%. I would allocate 50-55% of your investments to U.S. Equities and 30-35% to International Equities. The rest I would keep in cash or allocate to an intermediate U.S. government bond fund listed above. Again, given where bond yields are, diversifying into bonds represents a high opportunity cost relative to expected returns in equities over a five to 10-year time-period. 

Expect to retire in the next 5 years

If you expect to retire within the next 5 years, I recommend reducing risk in your portfolio and moving towards a 60% equity and 40% bonds allocation at your retirement date. For example, if you expect to retire in 5 years and you are currently at 80% equities, you would reduce your exposure to equities by 4% per year until you get to 60% at retirement. Rather than selling equities and likely incurring capital gains taxes, the best way to get there is to increase your allocation to your bond portfolio to get to 40% bonds. So why own bonds at all given the weak expected returns we’ve discussed? There are a couple of reasons including reduced volatility in your portfolio as well as the fact that bonds typically perform well when equities do poorly, so your bond allocation will act as a hedge against declining equity markets near your retirement date. 

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