Uncovering the Benefits of Asset Allocation
What you will learn
- Why it’s important to match asset allocation to life stage
- What target-date investing is and the potential benefits of staying invested
- Challenges for investing in retirement
Asset allocation and life stage
Asset allocation is a strategy of dividing an investor’s portfolio among different asset classes based on three key factors – investment objectives, risk tolerance, and time horizon. Since these factors may change over the course of an investor’s lifetime, asset allocation may also change over time.
All investments involve a certain degree of risk or volatility. Investors who have plenty of time to ride out short-term market fluctuations will typically want their strategic asset allocation to focus on growth-oriented investments, such as stocks, and move to a more conservative approach as they draw closer to retirement. However, investors may also consider short-term goals that demand a certain amount of liquidity, such as buying a house or car, and funding a child’s education.
How may asset allocation change through life stages?
The pie charts below illustrate how an investor’s asset allocation might progress over different life stages leading to retirement. Notice that the allocation of the investor with 30 years to retirement has a greater concentration on equities which shifts to a more conservative, lower risk approach as the investor approaches retirement.
For Illustrative Purposes Only.
Figure is not indicative of the past or future results of any PIMCO product or strategy. There is no assurance that the stated results will be achieved.
In general, an investor’s strategic asset allocation should be revisited after major life events as this can cause investment goals to change. Periodic rebalancing is also required to maintain strategic asset allocation in light of changes in the market.
What is target-date investing?
One way for investors to effectively manage their asset allocation over the different stages of life is through a target-date investment. Target-date investments are typically available in a mutual fund structure, and are rebalanced by the portfolio manager progressively over time in order to deliver an age-appropriate asset allocation. This process is known as a glide path.
Asset allocation is designed to optimize the goals of retirement income, return maximization and diversification of investments to generate attractive long-term returns, no matter the economic conditions over the investment horizon.
What are the benefits of staying invested?
The purpose of a strategic asset allocation is to provide a long-term strategy for a portfolio. Investors are more likely to reach their long-term goals if they remain invested and avoid short-term, reactive decisions that may take them off course.
Why? Investors are sometimes tempted to jump in and out of certain investments like stocks or bonds in an attempt to time the market – that is, to try to predict which asset class will perform best at a particular point in time.
This is an extremely risky strategy that few professional investors are successful in pursuing. Markets generally normalize, and when they do, those who stay invested may benefit more than those who don’t.
Reactive decision making known as “flight to safety” happens in markets periodically. During these periods, investors move their money from assets perceived as riskier into less risky assets such as cash, in response to market conditions.
For example, investors concerned about the value of their investments as interest rates rise might be tempted to move their assets into money markets which have minimal exposure to interest rate risk. However, this flight to perceived safety could come at a steep price. Moving to money markets generally means giving up yield, which in the long run can often lead to lower returns.
How can asset allocation work through retirement?
As investors approach or enter retirement, their investment needs may change. In particular, with increasing life expectancy in the developed world, longevity risk has become a key challenge in retirement as investors grapple with capital preservation to ensure that they don’t outlive their savings, while aiming to grow their assets to protect against inflation.
It may make sense for retirees to calibrate or adapt spending patterns to align with their investment performance. Additionally, many retirees may find it helpful to combine financial market investments with longevity protection strategies that seek to provide income as they age. Longevity protection strategies can play an important role in budgeting and reducing the catastrophic risk of running out of money.
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