Bedel Blog

May 15, 2019

Customize Your Approach to Asset Allocations

When’s the right time to dial back the risk in your portfolio? This question is one many retirees (or soon-to-be retirees) face concerning their ability to withstand large fluctuations in the value of their portfolios. Take too much risk and you jeopardize the money you plan to use in the near future. Take too little risk and you may fall short of achieving the returns necessary to reach your long-term goals. It’s not something you should leave up to chance.

Two Approaches to Managing Risk

One method of determining an appropriate mix between stocks and bonds in your portfolio is the Five-Year Rule. You can apply this concept if you are nearing or in retirement or if you

anticipate you’ll need to withdraw a large amount from your portfolio along the way. Here’s how it works. The value of any funds you are expecting to withdraw during the next five years should not be invested in equities. Instead, this amount should be shifted to more capital-preserving strategies such as bonds or money market funds. Since stocks can be volatile and unpredictable in the short-term, it’s prudent to make these asset allocation shifts ahead of time. That way, the money you are relying on being available isn’t exposed to a potential market downturn just when you need to withdraw it.

Lifecycle funds are a common solution that many people use when they are unsure how to customize their asset allocations to fit their timelines. While these funds may potentially be suitable for investors with a given target retirement date, specific situations often require a more personalized approach. For example, a popular 2020 target date retirement fund (meaning investors in this fund should be looking to retire next year) currently has 55 percent of its assets in bonds.

Five-Year Rule versus Lifecycle Funds

Let’s use an example to see how each of these two solutions might play out. Charlie has a $1,000,000 portfolio and expects to withdraw $50,000 per year in his first five years of retirement. If he uses the Five-Year Spending Rule for bond allocation, he would need $250,000—or 25 percent of its assets—in capital-preserving bond investments to cover his next five years of spending. If he participates in a lifecycle fund, he could end up with $550,000 in bonds, a far more conservative allocation. With this option, Charlie is likely to have missed out on potential long-term returns and is keeping too much of his portfolio’s assets in stable investments.

While this is just one example, it should illustrate the importance of taking a customized approach to your asset allocation, especially as you approach retirement. A one-size-fits-all approach may not fit your needs!

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Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.