Most of us can remember a time when our parents had to use every trick in the book to get us to eat a balanced meal. When we were young we didn't concern ourselves with proper nutrition or a balanced diet, we just wanted to eat what tasted good. The saying: "save room for dessert" was my favorite and when I was younger, I liked to save a lot of room… for dessert.
The lessons we learned at the dinner table about eating a balanced meal help to illustrate the proper use and importance of asset allocation in your retirement account.
The investment options available to you in your retirement plan can broadly be lumped into one of three main asset classes: equities (stocks), fixed-income (bonds), and cash/cash equivalents.
Asset allocation most simply means how you divide your money among these "asset classes." Each asset class has a different degree of risk/reward characteristics. For example the equity funds (or stock funds) in your plan will often provide the opportunity for potentially higher returns, but they will also tend to carry the most risk.
Much like my younger days of indulging in the extra dessert, a younger investor can often tolerate a greater amount of risk exposure. Although it probably wouldn't be wise to eat nothing but dessert at any age, a younger person can typically accept the risk. Likewise, a younger investor can typically afford to allocate the majority of their retirement account assets toward equities (stocks) which tend to offer the potential for higher returns, but with a greater degree of risk exposure.
As we get older the need for proper nutrition tends to become more and more apparent. Eventually we reach a point where our diet needs leave little room for indulgence. Our diet becomes more balanced with a focus on foods that will improve and preserve our health.
Proper asset allocation for many investors will follow a similar path. Over the years, as you move closer to retirement your allocation will begin to reduce exposure to equities (stocks) and increase exposure to the other categories to increase safety. Your investment objectives shift from growing the balance of your savings to preserving the balance of your savings. At this point you will likely maintain some exposure to equities, but cash/cash equivalents as well as bonds become primary positions in your account.
Although these examples are somewhat of an oversimplification, the broader point is that asset allocation will depend on the needs of the individual investor. Having an understanding of your tolerance for risk and longer term objectives and how asset allocation fits into this is an important step in determining how to invest in your retirement plan.
If you have any questions about your asset allocation or retirement strategy, contact our advising team at 877.627.8401 or email@example.com.
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Smart401k is a web-based investment advisory service providing unbiased recommendations to help people invest in employer-sponsored retirement plans. Smart401k provides service to nearly 11,000 clients who collectively have more than $2 billion in assets. Plan participants receive personalized, fund-specific investment recommendations and the support of professional investment advisers available to discuss all investment questions. Based in Overland Park, KS, Smart401k is online at Smart401k.com.