When it’s time to rethink your asset allocation

Unless you happen to be an average-size person with perfectly balanced proportions, the clothing you buy may or may not fit perfectly. A skilled tailor can make a wardrobe seem almost custom-made by taking up a hem, adjusting a cuff, or making a few nips and tucks here and there.

The same applies to your portfolio. A standard asset-allocation mix (such as a  model portfolio ) may work well for the “average” investor, but one size doesn’t always fit all.

Here are some of the situations in which you might want to consider adjusting your portfolio for a better fit.

You need more cash for short-term expenses

The “bucket approach” is a great way to tailor your asset allocation to better fit your specific needs.

The general idea is to keep one to two years’ worth of expenses in highly liquid securities to help meet short-term cash needs (plus an additional five years’ or more worth of living expenses in high-quality fixed-income securities to provide income and stability). That way you won’t have to scramble to sell securities to meet your ongoing expenses. In effect, this approach is a way of building a tailored asset allocation from the bottom up.

You’re saving for a short- or intermediate-term goal

Similarly, make sure your asset allocation accounts for both longer- and shorter-term goals.

If you have upcoming events on the horizon such as a home purchase, college tuition, a wedding, or a big vacation, make sure you have enough of your portfolio in moderate-risk assets (such as high-quality short- or intermediate-term bond funds ) to fund these goals.

You have a big chunk of your wealth in company stock

It’s far more likely for a single stock to have large losses than a diversified mutual fund, so it’s wise to  prune any stock holdings  so they make up less than 10% of your portfolio. If you’ve received significant equity awards as part of your total compensation, though, consider how to do so without realizing hefty capital gains.

You and your spouse aren’t the same age

If your spouse is more than five years older or younger than you, your portfolios should probably look a bit different.

The younger spouse can afford to have a higher equity weighting and a more aggressive risk profile, while the older one will want to dial back risk. If you hold assets jointly, consider using a blended approach based on the average of your two ages.

You expect to live unusually long based on your health and family history

If you’re fortunate enough to have relatives who lived into their 90s or beyond, it makes sense to plan for a longer-than-usual life expectancy.

You can probably afford to take on more risk with more exposure to equities and high-risk assets. From an actuarial perspective, each year you live means your life expectancy gets longer. Some experts (such as Michael Kitces and Wade Pfau) even argue for a “ reverse glide path,” which increases equity exposure as you get older instead of the reverse.

You have a serious health problem that makes your life span shorter than expected

On the flip side, if you’re dealing with a terminal illness, make sure to keep your portfolio conservative enough to meet higher-than-expected  health care expenses  and provide yourself with whatever you might need to make your remaining months and years a little more comfortable.

You might want to leave a  legacy  to your children and grandchildren, but keep in mind that the gift of your time—not money—will probably be the most meaningful. So, don’t feel guilty about spending down your assets if you find yourself in a situation where you need to.

You’re worried about not having enough assets to last throughout your lifetime

If you weren’t able to save and invest early in your career, your portfolio balance might be relatively low.

Taking a hard look at your spending is the most important step you can take in this situation. But while it might be tempting to ramp up your equity exposure to try to make up lost ground, it’s more prudent to take the opposite approach because a small portfolio has less room to absorb market losses.

You’re fortunate enough to have a pension or other stable income streams

Because a pension is literally a fixed income, it functions like a bond position in a portfolio, so you can afford to increase the equity weighting with your other assets. Social Security works the same way: Your monthly benefits won’t grow beyond a small cost of living increase, but it’s effectively a  bond like income stream.

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This article was provided to The Associated Press by Morningstar. For more personal finance content, go to  https://www.morningstar.com/personal-finance

Amy Arnott is a portfolio strategist at Morningstar.

12/04/2024 06:00 -0500

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