How to construct a retirement portfolio
E*TRADE from Morgan Stanley, in collaboration with T. Rowe Price09/23/21
A basic component of any investment portfolio is its asset allocation. This is the mix of investments that you hold—ideally, a mix that fits your goals, risk tolerance, and time horizon. For many investors, this mix will change over time, because, as their lives and circumstances change, they make adjustments to it. Let’s take a closer look.
Balancing risks and potential returns
At the highest level, investors can create an asset allocation across three primary types of investments, or asset classes: stocks, bonds, and cash. When investors are younger and retirement is still years down the road, many of them are comfortable investing more of their money in riskier assets such as stocks and less of it in bonds and cash. Although the value of stocks fluctuates on a daily basis, they have historically offered the highest returns of any major asset class over long periods of time. Of course, past performance is not a guarantee of future results.
One risk with stocks is that they tend to experience large price swings, or volatility, over short periods of time. But that can be less of a concern if you have a long-term investment horizon with more time to recover from stock market dips.
When the time horizon starts to get shorter, it may be appropriate to adjust a portfolio's asset allocation. Many investors shift a portion of their holdings from stocks to bonds when they’re approaching retirement or have already retired. This may help reduce volatility in a portfolio because, historically, the prices of bonds don't swing up and down as much as stocks in the short-term. Of course, bonds have historically also had lower returns over long periods, but the reduced volatility may be an important benefit when you don’t have as much time to recover from market dips. And even though their returns may be lower, bonds may still provide some opportunity for growth over a retirement that could last decades.
The third major asset class—cash—has historically offered the lowest average returns but also the least amount of volatility.
Combining stocks, bonds, and cash in different proportions allows you to spread risk across the different assets and, in turn, across your portfolio, while managing the balance between growth potential and short-term volatility.
Remember that investing for retirement calls for a long-term perspective. Focusing on the short-term may lead to emotional decisions. Selling assets in a down market is an easy trap to fall into when market fluctuations cause short-term losses. Those are good times to remind yourself that, historically, the volatility of stock returns is reduced over longer time periods. Staying invested through downturns and corrections may help you take advantage of long-term growth potential.
To some investors the idea of creating an appropriate asset allocation and managing a portfolio can seem overwhelming, but there are solutions that do it for you. These include balanced or target date funds, as well as prebuilt or professionally managed portfolios.
Making a plan to save and invest
What about the question of how much you should be investing? One rule of thumb is that most people should invest at least 10-15% of their income, including any contributions that may be available through a workplace plan, like a 401(k). When putting together your overall plan, keep in mind that different account types have different contribution limits.
If you can’t invest 10-15% now, then invest what you can and plan to increase the amount each year. If something crops up and you temporarily need to invest less, then make sure to boost your contributions after the temporary needs are met. And on the flip side, if your income increases, consider bumping up your contributions.
Ultimately, the basic idea is fairly simple. Your retirement investing journey starts with an appropriate asset allocation. Then, be ready to adjust it as your life and time horizon change. These are key steps in the process of investing towards the retirement you want.
T. Rowe Price, is a global investment management firm with $1.31 trillion in assets under management*. T. Rowe Price is focused on helping investors achieve more confident futures with a strategic investing approach and comprehensive platform of solutions.
*As of 6/30/22
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