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By Christine Benz | 01-18-2018 02:00 PM

Risk Capacity and Asset Allocation Go Hand in Hand

When checking your mix of stocks, bonds, and other assets, keep your time horizon for the money top of mind, says Christine Benz.

Christine Benz: Hi, I’m Christine Benz for Morningstar.com.

Investors spend a lot of time thinking about the specific securities they'll use to populate their portfolios, but their allocations to the major asset classes will actually be a more important determinant of how their portfolios behave. If you're tuning up your portfolio, checking up on your asset allocation should be near the top of your checklist.

Even investors who haven't been actively adding to their portfolio's stock weightings in recent years will find that their portfolios' equity weightings have increased. That's thanks to appreciation in those positions. A portfolio that was 60% stock/40% bond back in early 2009 would be 84% stock/16% bond in mid-January 2018.

Investors often wrestle with how much to hold in stocks and how much to park in the other asset classes. A key concept to bear in mind is your risk capacity; in other words, how much can you afford to lose given how close you are to needing your money? If you're many years from retirement, your risk capacity is very high; you can afford to invest the bulk of your portfolio in higher-returning assets like stocks. Even though stocks are more volatile, there’s a limited chance you’ll have to tap your assets at a low ebb.  

On the other hand, if you have a shorter spending horizon for at least a portion of your portfolio, it's wise to steer a portion of that money into safer assets that won't experience big fluctuations in their principal values. You don't want to risk having your investments be in a trough when it comes time to pull your money out. My bucket strategy calls for having two years' worth of withdrawals in cash, another eight years' worth in bonds, and the remainder in stocks.

Thanks for watching; I'm Christine Benz for Morningstar.com.

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