Asset allocation

Asset allocation is the practice of spreading investments across various asset classes to balance the risk and potential return of a portfolio. The three primary asset classes involved in asset allocation are stocks, bonds, and cash alternatives:

• Stocks: May help bring higher growth potential, but also come with increased risk. Over the long term, stocks tend to outperform other asset classes, making them suitable for investors with a higher risk tolerance or a longer time horizon.

• Bonds: Considered less volatile than stocks and may offer a predictable income stream through interest payments. They are valued for their stability, particularly for those nearing retirement who prioritize capital preservation over high growth.

• Cash equivalents: Include assets such as money market funds, which may offer low risk and high liquidity. While they can help provide stability and preserve capital, they also offer lower returns, making them a more conservative choice.

In the context of retirement planning, asset allocation is a critical tool for helping to manage risk while pursuing growth over time. By diversifying¹ across asset classes, investors can create a portfolio that balances growth potential with risk management, helping them achieve their retirement goals more effectively.

Why asset allocation requirements matter in retirement planning

Asset allocation requirements are crucial in retirement planning as they guide the creation of a diversified portfolio that aligns with an individual's or a retirement plan's objectives. A well-structured allocation helps balance the growth potential of stocks with the income and stability provided by bonds. Several factors influence how asset allocations are set:

• Investment goals: The mix of assets depends largely on the investor's goals. For example, long-term growth-focused investors may allocate more to stocks, while those seeking short-term income might prefer a larger bond allocation.

• Time horizon: Investors with longer time horizons, such as younger employees, may want to consider investing more heavily in stocks, as they have time to ride out market volatility. In contrast, those nearing retirement may consider allocating more to bonds, prioritizing stability.

• Risk tolerance: Individuals or plans may vary in their appetite for risk. More risk-averse investors may allocate a higher percentage to bonds or cash equivalents, while those willing to accept greater volatility may lean toward stocks.

Many employers integrate asset allocation into the default investment options they provide, such as target-date funds in 401(k) plans. These funds adjust allocations automatically, becoming more conservative as the investor approaches retirement, aligning with typical allocation strategies.

Regular rebalancing², whether done annually or when allocations deviate significantly from their targets, helps keep a portfolio in line with the investor's goals and risk tolerance. Over time, the value of different assets in a portfolio may change, causing the allocation to deviate from the original target percentages. Click here to read about automatic portfolio rebalancing, which can help an investment mix maintain its desired allocation.

Benefits of allocation requirements

Adhering to predefined allocation requirements can offer several key benefits:

• Risk management: Diversifying investments across different asset classes can help mitigate risk, reducing the impact of a downturn in any one asset class.

• Goal alignment: Asset Allocations are designed to align with specific retirement goals, whether they focus on growth, income, or capital preservation.

• Reduced volatility: A diversified portfolio spreads risk across multiple asset classes, helping to reduce the impact of market fluctuations.

• Simplification: Following established allocation guidelines can help simplify the investment decision-making process. This helps ensure that portfolios remain balanced and in line with long-term objectives, without requiring constant monitoring or adjustments.

¹Diversification does not ensure a profit or protect against loss.

²Portfolio rebalancing does not ensure a profit or protect against loss.