Asset allocation involves dividing an investment portfolio among different classes of assets. Retirement asset allocation spreads your assets among several classes of investments with the goal of securing your finances after you retire. The best way to allocate your assets during retirement largely depends on the amount of financial risk you're willing to tolerate, as well as your investment horizon. Risk tolerance gauges the stability of an investment; an investment's horizon is the amount of time you intend to have your money invested in a particular asset.
Investment goals are always individualistic, as your retirement asset allocation will be. Begin by deciding the amount of risk to which you'd like your investments exposed. For a retirement nest egg, your investment strategy will most likely be risk averse, meaning that the portfolio includes less-riskier investments in order to preserve your assets and generate income for many years. Portfolio diversity is also extremely important in retirement asset allocation. Dividing your financial assets among several asset classes hedges your investments against systemic risk — that is, risk that effects every security in a market, not just a specific company or financial product.
After determining the degree of risk to which your portfolio should be exposed, choose the securities that will create the returns you expect. If your retirement asset allocation can tolerate more risk, invest in stocks or more volatile investments. A retirement portfolio could be more risk tolerant if it won't be your sole source of income during your retirement. If you plan to finance a substantial part of your retirement with a retirement portfolio, invest in bonds, money markets or annuities.
A well-diversified portfolio includes a mix of assets, including stocks, bonds, and, for a retirement plan, an annuity. Annuities are contracts between individuals and insurance companies, and they are widely used to finance retirement. The individual makes regular payments into the annuity, which grows for a predetermined amount of time without taxation; at its maturity, the insurance company returns the funds to the investor in regular intervals, with that money being taxed as income. Retirement asset allocation in bonds is often stable but not guaranteed.
Stocks have the potential for the greatest return on an investment, but they're also more volatile. Bonds are less volatile than stocks and offer lower returns. For stability, allocate a greater portion of your assets to bonds instead of stocks. Perhaps the safest of all investment categories is cash and cash equivalents. These include savings accounts, certificates of deposit, treasury bills and money market accounts. Allocate your retirement assets in such a way as to balance your risk and revenue requirements.