Asset Allocation For Retirement: Understanding Stocks And Bonds

One of the most common questions in investing is regarding the right asset allocation. The answer truly depends on your needs, risk tolerance and ultimately your financial goals, both now and in the future. While there are quizzes and questionnaires you can take online, and you can always ask your friends and family what they do, it’s better to understand the differences between the asset classes and then transpose that over your goals.

Start With Stocks

What you have allocated in equities and stocks would refer to your risk or growth asset. Stocks, at the most basic level, mean that you own shares of publicly traded companies. Over time, you’d expect that these assets would grow faster than both bonds and inflation rates. However, these are more volatile assets. While you may expect returns around 8 to 10% annualized, they’re subject to -30% years and +30% years. Historically speaking, his asset class is up.

Basics Of Bonds

With a fixed income or bond allocation there’s a lower risk because you’re owning a public company or municipality debt. Think of it this way – an equity owner is you owning your house, and a bold holder is the bank that holds the mortgage on a fixed term. Bonds are much less volatile than stocks and they’ve only had roughly 5 negative years since 1976 when the index began. Generally, stocks and bonds are not down in the same year, although it has happened once, and with the exception of 2022, even when bonds are down it is generally under 3% negative. While stocks can vary up or down 30%, bonds generally don’t vary more than 10% on either the plus or minus side.

Consider Your Assets On The Way Up And Down

Now that you have a basic understanding of each asset class, think about how you’ll apply that to your investing life, both on the way up and the way down. Think of your investing life in two phases.

The Way Up

In the first half of your investing life, you’re investing on the way up, meaning that you’re predominantly saving or in the accumulating phase. The important part of this phase is to have a good mix of stocks and bonds that give you the appropriate risk-adjusted rate of return that you’re comfortable with. In general terms, the more stock exposure you have, the better your returns will be over time but you’ll experience more volatility along the way. There’s no right formula for everyone and this must be vetted by how you personally react to market swings, and your financial goals, to determine the amount of risk that you need to take.

The Way Down

When you’re in the second phase of your investing life, you’re in the spending time. This may be the most critical part of your investing life since you really need to have your allocation correct, and it’s more dynamic. Not only do you need the right blend for continued growth, but you also have to have the right blend because you’re actually taking out money during this phase so you need to ensure that you don’t run out of investments while you’re withdrawing. You want to have enough assets that are appreciating so that your funds are growing, but still remain with enough bonds that you can continue to pull funds consistently regardless of what’s happening in the markets. The key during this phase is to have enough in your bonds so that you can sail through those market dips without selling off stocks.

Ultimately, it’s all about balance and what’s best for you. Working with a financial planner may help you to see the bigger picture in all of this, and to help you identify your risk tolerance.

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