The past year hasn’t been easy for many people. Stock prices have plunged, and many older adults have watched their retirement savings dwindle. Inflation has also wreaked havoc on many Americans’ finances, making it harder to pay the bills.
On top of that, many experts believe a recession could be coming in 2023. Whether that will actually happen is unclear right now, but if you’re on the verge of retirement, even the hint of a recession can be unnerving.
While you may not be able to prevent a potential recession, there is one step you can take to help protect your savings: Double-check your asset allocation.
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What is asset allocation?
Asset allocation refers to how your investments are divided up within your portfolio. It aims to balance risk and reward by offsetting some of the riskier assets in your portfolio with somewhat safer options.
The two major types of assets in most investors’ portfolios are stocks and bonds. Stocks generally see higher returns over time than bonds, but they also carry more risk — and they tend to experience more significant ups and downs during periods of volatility.
When you’re younger and still have decades until retirement, it’s often recommended to allocate the majority of your portfolio toward stocks and less toward bonds. Your investments will likely be hit harder during market downturns, but you still have plenty of time for your money to recover.
As you get closer to retirement age, though, you may not be able to afford a major hit to your savings. It’s wise, then, to gradually shift your portfolio more toward bonds as you age. You’ll likely see lower returns than you would by investing primarily in stocks, but your money will also be more protected against volatility.
Proper asset allocation by age
The right asset allocation for your portfolio will depend on your age and risk tolerance. The older you are and the less tolerance you have for risk, the more conservative your portfolio should be.
A general guideline is called the Rule of 110. Subtract your age from 110, and the result is the percentage of your portfolio that should be allocated toward stocks. So, for example, if you’re 65 years old, you’d allocate around 45% of your portfolio toward stocks and 55% toward bonds.
Even in retirement, it’s still wise to keep at least a small portion of your savings in stocks. If you invest your entire portfolio in bonds and other conservative investments, it will be much harder for your money to grow, and you risk running out of savings.
That said, your risk tolerance will also play a role in your asset allocation. If you’re more risk-averse, you may choose to invest more heavily in bonds. Again, you’ll likely see lower returns, but it may help you sleep better at night.
On the other hand, if you can tolerate more risk and have other sources of income besides your savings (such as Social Security benefits or a pension), you might opt to invest more in stocks to maximize your earnings. Just be aware that if we face a recession and the market falls, your portfolio could be hit harder.
One other critical step to protecting your money
Finally, it’s important to ensure your investments are not only properly allocated, but well-diversified, too.
A diversified portfolio essentially means you’re not putting all your eggs in one basket. Double-check that you’re investing in at least 20 stocks from a variety of industries, or funds that are already well-diversified. For bonds, it’s also wise to ensure there’s enough variety across types and sectors.
In general, the more variety you have within your portfolio, the more protected your money will be. If we do face a recession sometime this year, proper asset allocation and diversification can help your savings not only survive, but thrive.
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