Asset allocation
All investments fall into different groups, called asset classes. Stocks are one asset class, bonds are another and cash or cash-equivalents, like CDs, are another. The asset allocation you choose, which is the way you divide your money among these classes, is key to building a retirement portfolio that can provide the long-term return you seek, with the level of risk you are comfortable assuming.
It might seem as if putting all of your money into investments that have the most growth potential or, alternatively, into insured investments that protect you against losing principal, is the smarter approach. In fact, it's a fairly risky approach. By making both types of investments, you're gaining protection, not only against a fluctuation in value that could wipe out your savings, but also from inflation that reduces your buying power.
When you invest in many different types of investment accounts — from IRAs to taxable accounts — you want to allocate your assets across the range of your accounts. So, for example, you might invest your taxable accounts for growth and your IRA for income. Or you might try to allocate each account across the available classes. It's up to you, and really depends on many factors, including:
How many years you have before you retire
How much money you have in each type of account
Your personal tolerance for risk
Your current and anticipated tax rates
Inflation
Doing the math
The exact asset allocation that's right for you depends on your goals and your risk tolerance as well as the time you have until retirement. In general, the closer you are to retirement age, the more conservatively you may want to invest.
