Allocating your assets correctly in a manner that fits your risk tolerance, investment objectives and time horizon is one of the most basic decisions and processes in retirement planning. Investors who fail at this task can put themselves at risk of outliving their assets or losing more money than they can afford to. Here are several key mistakes that many retirement savers commit when they allocate their retirement assets.
Not Taking Enough Risk
Although preservation of capital is a key concern for most retirement savers, it is also necessary to maintain an adequate hedge against inflation so that you don’t run out of money. The amount that you need to allocate to equities in order to accomplish this will vary according to your risk tolerance and time horizon, but putting everything into guaranteed instruments and hoping that that will last you is a risky proposition unless your portfolio is exceptionally large. (For more, see: What Is Your Risk Tolerance?)
Taking Too Much Risk
If you’ve had a good run in the stock market and you’re comfortable with the ups and downs, then keeping your portfolio in equities may seem like a good idea. But if you’re retired, then you no longer have as much time to make up for market losses, so it’s time to start thinking about your drawdown risk. This risk measures the amount of time that it will take to recoup your market losses after a bearish period. You can end up really hurting yourself if you have to take material distributions from your retirement assets when prices are down, because you won’t have as many shares left when the market recovers. You need to be able to distinguish between your risk capacity and your risk tolerance.
Allocating Based on Incomplete Information
If you are structuring your distribution schedule from your retirement plan, remember to factor in other sources of income such as Social Security or a pension so that you are looking at the whole picture. If you are lucky enough to get a pension, then you can probably take a higher level of risk in your portfolio because you already have a key source of guaranteed income. (For more, see: Combating Retirement's Silent Killer.)
Being Unaware of Your True Asset Allocation
This is a greater factor if a substantial portion of your portfolio is invested in actively-managed mutual funds. Your funds may all own substantial holdings in one or a few stocks, which means that if you also own any of those holdings yourself outside the fund, then you may be over-weighted in those securities. Morningstar Inc.'s (MORN) X-Ray Screener is an excellent tool that can help you to see how much of a given individual security you really own in your portfolio.
Leaving Out Other Financial Goals
If you intend to leave a legacy for your children or other heirs after you are gone, then you may need to weight your portfolio more heavily in equities in order to achieve a higher rate of growth. You may also want to look at purchasing a life insurance policy if you don’t have any. One of the new policies that offers accelerated benefit riders can also provide you with protection against disability or long-term care expenses. (For more, see: Avoid These Retirement Portfolio Mistakes.)
The Bottom Line
These are just some of the mistakes that financial planners see retirement savers make on a regular basis. Other errors can stem from not understanding the risks that come with a given type of investment or discounting one’s financial behavior. This is why it’s a good idea to work with a financial planner who is trained in retirement planning and can help to guide you with your asset allocation. (For more, see: 5 Retirement Planning Mistakes You Might Already Be Making.)