Where to put your retirement funds

March 12, 2008 8:38:44 AM PDT
Quick, what's your stock allocation? Not sure? Then it's time to find out.

Knowing what percentage of your investment portfolio is allocated to stocks is essential to achieving your financial goals.

You may think you're a conservative investor, but if 80 percent of your portfolio is invested in stocks, then you're not and you may be in for some unpleasant surprises.

On the flip side, you may consider yourself an aggressive investor hoping to retire by age 55. But you're likely to be working a lot longer if just 35 percent of your retirement savings is dedicated to stocks.

Either way, knowing what percentage of your long-term savings is invested in stocks ? compared to bonds and cash ? is critical to achieving your goals.

I know the average 401(k) investor may not be interested in the finer points of their asset allocation: How much in international small caps compared to the energy sector? But they need to know at least the big picture ? stocks, bonds and cash.

When I talk about your stock allocation, I do not simply mean the money you have invested in individual stocks. For most individual investors, I mean money invested in stock mutual funds as well as the few individual stocks you might own.

To figure out your stock allocation, pull out your latest statements from your 401(k), IRA, brokerage or other investment accounts. For each, look at the total account balance and then add up those figures. That's your overall portfolio.

Next, try to categorize each individual investment: stocks, bonds or cash. You might even need an "other" category. Once done with the categorizing, add up the totals for each category. Divide each category amount by the total portfolio and then multiply by 100. Those are your allocation percentages for the major asset classes.

But what do the numbers mean? And what should your stock allocation be?

At its most basic level, the stock allocation figure tells you how aggressive your portfolio is and its risk level. The higher the number, the more aggressive the portfolio and the more subject it is to volatility.

Over the long term, a higher stock allocation likely will mean higher returns, but over the short term, it also will mean a higher potential for losses.

As a general rule, I would consider anyone with a stock allocation of 50 percent or less to be a conservative investor, 51 to 70 percent moderate and over 70 percent aggressive.

A conservative allocation is appropriate for those with shorter time horizons, such as retirees, and those who are kept awake at night by small drops in their portfolio values. An aggressive allocation is suited to younger investors with decades until retirement, those with an appetite for risk and those whose financial circumstances allow them to absorb short-term losses.

Each individual is different. You should consider where you rank on the conservative-to-aggressive scale. How much time do you spend worrying about the recent stock-market tailspin? How important to you is it that you achieve the highest possible return?

There are a variety of investment risk tolerance surveys available online that will help you assess yourself as an investor.

For my own portfolio, I set a stock-allocation target of 85 percent. That may seem too aggressive for some, too conservative for others. But it's right for me.

I checked my allocation the other night and found my stocks share had dropped to 83 percent. That is a result of the severe drop in stock prices since the beginning of the year. What it means is that if the lower stock prices persist, then I should consider moving money from bonds into stocks as part of an annual rebalancing.

Once you know your overall stock allocation, then you might consider a look at what percentage you hold in large caps, mid- and small caps and foreign stocks.

Now, figuring out your overall stock allocation is fairly simple. The hard part is determining the right percentage for you as an individual. This is not a subject studied closely by the average investor.

One way to figure out an appropriate stock mix is to study the allocations of target-date mutual funds, which are geared toward investors expected to retire in or around the specified year.

For instance, the Vanguard Target Retirement 2030 Fund, which is geared toward people like me in their early 40s, featured an 87-percent stock allocation as of late January, according to the Vanguard web site.

The T. Rowe Price Retirement 2015 Fund for those in their mid- to late-50s held 67 percent of its assets in U.S. and foreign stocks as of the end of last year.

I'm not suggesting these exact allocations that should be used by every investor in these age groups. Rather, they are reasonable starting point to set your own stock target.

And what I'm proposing here is a simple start toward a better portfolio.

Now, tell me, what's your stock allocation?

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com