By mirroring asset allocations of target date funds, you can get a starting point for asset allocation and risk.
In my post about risk tolerance and time horizon, I wrote about what I consider two most important factors to contemplate before you start investing. The time horizon is typically the easiest to figure out, even if it’s a range.
I recall looking at the risk questions in my 20’s and thinking, hey, I’m ready for 100 percent stocks, bring it on! The market corrections of 2000 and 2008 really tested that way of thinking though, and have sense helped me rethink my attitude toward risk.
A Simple Template for Asset Allocation
If you are intent on going it alone with investing, one way to explore what asset allocation mix is right for you is to look at target date funds. The major 401k providers have them (Fidelity, Vanguard, etc.). You can go to their website and select the target date fund that matches your retirement date and then look at how that fund is invested.
So if you’re 40 and want to retire at 65, you can pick the 2045 target date fund and look at how this fund allocates its investments among different classes of assets. A quick look at the Fidelity Freedom 2045 fund, and you can see (at the time of this writing) it is mostly a mix of domestic and international equities with a much smaller weighting to bonds.
I mention at the time of this writing since Fidelity (or Vanguard, or whomever) will rebalance this mix periodically, with the idea that as we get closer to 2045, the fund will allocate money from riskier to safer assets.
My take on this is that if you went to a financial advisor, and the only thing they knew was the date you plan to retire (or they just assume you retire at 65) then they’d place you in one of these target date funds…and you probably won’t do all that bad either as long as the fees are reasonable.
This is a pretty simplified way of going about asset allocation and all you really have to think about is your time horizon. That is, how long you will be accumulating and investing and when will you need to withdraw money from your investment. The risk tolerance is already thought out in the target date fund. Personally, I think it is still a good idea to revisit the risk questions and regularly assess your risk tolerance. Eventually we will have a stock market correction, a recession, or other big event that sends our investments on a wild ride. Asking these questions at different periods will help you gauge your true risk tolerance and maybe change the way you think about investing.
If you decide to model your portfolio on one of these funds, just be sure to revisit it periodically. They are actively managed, and over time, should rebalance into a less riskier balance of equities, bonds or other investments. There also could be other rebalancing such as industry weighting, focus on certain countries, etc. So it’s not fire and forget, make sure you check back.
Some Examples
Example 1 is someone that is 5 years out from retirement. I looked at the Fidelity Freedom 2025 target date fund (FFTWX).
Example 1 – 5 years out from retirement
Example 2 is for someone that is 20 years out from retirement, and uses the Fidelity Freedom 2040 target date fund (FFFTX).
Example 2 – 20 years out from retirement
As you can see, the difference between Examples 1 and 2 is asset allocation. The percentage of stocks decreases and bonds increase as you get closer to retirement using this model.
You can also construct your own portfolio with low fee investments of your choosing, by using the asset allocation model in a given fund. Heck, you can even go beyond target date funds and build your own portfolio off of other existing mutual funds. I have come across one financial advisor that uses exchange traded funds (ETFs) to build portfolios in similar fashion.
Don’t Forget to Revisit
If you do decide to go it alone, the one thing to be really mindful of is rebalancing. Part of that fee that you pay for these funds is to pay for professional money managers to rebalance or re-weight the fund based on what they perceive is happening in the economy and what they perceive is a proper amount of risk given ones retirement age. You’re paying for the convenience of someone else to do all the work.
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