How best to populate your retirement portfolio, or decide which of your current holdings are a good fit? To help you knock those tasks off your list, it's crucial to think through your own situation, what you're trying to achieve, and your characteristics as an investor. As you do so, here are the key questions to ask.
Question 1: Will you employ multi-asset funds or discrete holdings for your stock and bond exposure?
This is one of the first forks in the road that confront many investors saving for retirement: Hand-select investments, or opt for an all-in-one vehicle that encompasses varying asset classes, such as an allocation or target-date fund? Here are the pros and cons of each tack.
Employ discrete stock, bond, and other holdings.
Pros: The big advantage of using a building-block approach versus employing an allocation or target-date fund for your retirement portfolio is that you can exert tighter control over your asset allocation. You can customize your stock/bond mix to suit your own situation. Some investors may also value the ability to make tactical adjustments to their asset allocations based on their market outlooks--raising cash when long-term assets seem expensive, for example. And while multi-asset funds will typically assemble a portfolio from the "house" brand of mutual funds, the investor who maintains discrete stock/bond holdings is free to graze across fund families. Finally, retirees who maintain discrete stock/bond holdings can also be strategic about which part of the portfolio they tap for living expenses; they can sell stocks in a lofty market, for example, while harvesting bond and cash assets in tough equity markets.
Cons: A retirement portfolio with distinct holdings will require more work to set up and maintain. Moreover, investors who are in charge of maintaining their own portfolio mixes may be more inclined to make adjustments to their programs, and those tweaks won't always be well timed. For example, in the wake of the bear market, many investors bought bond funds, whereas in hindsight it was a wise time to buy stocks. (In fact, many all-in-one funds were rebalancing into stocks during that period.)
If you go this route: Get some professional advice on asset allocation, either from a financial planner or by taking time to learn about asset allocation on your own. And be careful with tactical maneuvers, as even professional money managers have difficulty executing them on an ongoing basis.
Opt for a multi-asset fund or target date fund.
Pros: Convenience. Employing multi-asset funds, whether a static-allocation vehicle or a target-date fund, can help reduce the moving parts in your portfolio. Moreover, target-date funds do the heavy lifting of asset allocation for you. Not only do they set an initial, age-appropriate allocation, but they also manage it on an ongoing basis, making your portfolio more conservative as your goal date nears. Using a set-and-forget-it multi-asset fund can also help ensure that you make changes that are psychologically difficult but helpful to your bottom line--for example, rebalancing.
Cons: Multi-asset funds may be reliant on a subpar lineup of underlying investments, or may at least have a few weak links in their lineups. And as useful as they can be for retirement savers, target-date funds are blunt instruments: They use a single factor--anticipated retirement date--to set their asset allocations. But people retiring in a given year might have wildly different situations that call for different asset allocations: The person retiring in 2020 with a $3 million portfolio almost certainly has different needs than the one retiring in that same year with $250,000.
If you go this route: Be selective. Also, be sure to monitor other accounts you hold in addition to your target-date fund, because the allocations you make there can undermine what's going on in the target-date fund.
Question 2: Will you aim to dampen volatility in your portfolio or will you be more aggressive?
Another consideration when selecting holdings for your portfolio is the level of volatility you're comfortable with. The past 10 years in the equity market--and the 10 years that preceded them--have provided a great laboratory for examining your own behaviors. If you've reacted poorly to market volatility--by selling yourself out of positions when they were in a trough, for example--you may want to tweak your portfolio and its holdings to emphasize downside protection. On the flip side, if you know that you can handle higher volatility if the prospect of higher returns comes along with it, you might consider shading your portfolio toward the aggressive.
If you're aiming for a lower-volatility portfolio: The main way to bring your portfolio's volatility level down is to adjust its asset allocation, but you can also reduce your portfolio's ups and downs by focusing on investments that take a risk-conscious approach to a given asset class.
If you can tolerate more volatility: Have you been positively stoic through the market's gyrations? If so, you may want to tweak your portfolio--both its asset allocation and your investment selections--to put a greater emphasis on investments that have the potential for higher long-term rewards, even though they come with higher volatility. For example, a highly concentrated equity fund, while not for the faint of heart, could serve as a core equity position for your retirement portfolio.
When it comes to selecting investments for your retirement portfolio, I strongly believe that less is more. I'm a big fan of mutual funds and exchange-traded funds that provide broad diversification at a very low cost and require very little in the way of ongoing oversight. From that standpoint, it's hard to beat a portfolio that’s anchored in total market index funds. Retirees might also consider adding an inflation-protected bond fund, since those bonds don't appear in total bond market index funds. Well-managed active funds can serve a valuable role in retiree portfolios, too, especially if the manager pays attention to limiting downside volatility. As always, if you're buying an active fund, be sure to keep a close eye on costs, as high expenses will have a direct negative effect on your returns.