Your retirement assets might be divided among a number of sources, such as Social Security, a company pension plan or 401(k), an individual retirement account and personal savings. Some of those sources give you little or no say in how your money is invested, but you can control the mix of stocks and bonds you hold in your personal accounts. Chances are the mix of investments will shift as you draw closer to retirement.
The U.S. Securities and Exchange Commission refers to the way you divide your investment dollars between asset categories, such as stocks and bonds, as asset allocation. Asset allocation goes even further to define how you invest in different securities within asset categories. For example, you might divide your stock investments among large cap stocks, small cap stocks and international stocks. Your bond investments might include high-quality corporate bonds, tax-exempt municipal bonds and low-risk U.S. Treasury bonds.
One of the most powerful allies your investment portfolio has is time. If you have enough time, your portfolio can overcome a big risk that didn't pay off. Even small regular investments, and small returns on those investments, can grow into a handsome retirement account, given enough time. As you near retirement, you don't have as much time, so you might not be able to afford to take that big risk. If you didn't start investing while you were young, you might need to earn a higher rate of return on your stocks and bonds to make up for lost time.
The balance between stocks and bonds in your investment portfolio will be affected by how you view risk. The basic rule of investing: Higher potential rewards involve higher risk. The converse is not always true. Just because investments are risky, doesn't mean they offer a higher reward. At least in theory highly rated, investment-quality bonds have traditionally been viewed as less risky than equity investments such as stocks. The American Association of Individual Investors recommends investors who are nearing retirement, those over 55 years old, hold a 50/50 mix of stocks and bonds.
A properly diversified investment portfolio when you're nearing retirement should include a range of different stocks and bonds across a number of categories. For example, the American Association of Individual Investors suggests 40 percent of your portfolio should be in intermediate-term bonds and another 10 percent in short-term bonds. Twenty-five percent of a conservative portfolio should be in the stocks of large cap companies, 10 percent each in medium cap and small cap companies, and 5 percent should be in the stocks of international companies.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.