How to Choose an Asset Allocation

The number of investment options available for your retirement savings can be daunting. This article helps you decide which ones are appropriate for your situation.

Difficulty: Moderate

Instructions

Things You'll Need:

• Internet access
• List of funds available for investment

1. Determine your "time horizon". That is, when will you need to withdraw the money you're investing? This doesn't have to be exact-- "roughly 10 years from now" or "roughly 30 years from now" is sufficient.

2. Determine your personal tolerance level for variability. In general, the longer your time horizon the more variability you can safely have in your funds' performance. However, you may not be comfortable investing in the most variable funds out there, or may not be able to handle seeing one of your funds drop 15% in a month.
   
   It's important to be honest with yourself about your tolerance level before you make an investment that will cause you stress.

3. Choose your asset "mix". For example, a young investor planning for retirement might choose an aggressive mix of 100% stocks, while someone closer to retirement (say, 50) might be more conservative and choose something more conservative like 50% stocks and 50% bonds.
   
   The time horizon and variability tolerance will help you decide whether to invest aggressively or conservatively. If your time horizon is 20 years or more, 100% stocks is a reasonable mix. For time horizons under 20 years, a rule of thumb is to double your time horizon and add 20 or 30% (depending on your variability tolerance) to determine the percentage of your assets to invest in stocks. For example, if your time horizon is 10 years and you have moderate variability tolerance, your percentage of stocks could be 10 x 2 + 25% = 45 percent.

4. Before you choose your funds, consider the tax status of each of the investment vehicles available to you. The money invested in a 401k or regular IRA is generally before tax, while money in a Roth IRA is after-tax. You'll pay tax on the 401k and regular IRA money when you withdraw it, but the Roth IRA money is tax-free at withdrawal.
   
   Therefore, you want to put the funds that have the highest expected return (and thus the largest growth potential) in your Roth IRA so that you get those extra returns tax-free at withdrawal. Your funds with lower expected returns go in the 401k or regular IRA to reduce the tax bill at withdrawal.
   
   Other assets with special tax status (such as municipal bonds or stock options) are beyond the scope of this article.

5. Choose funds from those available that fit your time horizon and variability tolerance, considering the tax status of the fund they're in. For help deciding between two funds, see the article "How to Choose a Mutual Fund for your 401k or IRA".

Tips & Warnings

• You can have multiple time horizons. Roth IRA money, for example, can be used to help purchase a home or to finance your retirement.
• Remember that 401k and IRA money have age thresholds for penalty-free withdrawal. Make sure to consider those when setting your time horizon.
• Past performance of a particular investment does not guarantee future success.

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on 9/21/2009 visit http://www.LeeSmith.info for more information.