Asset Allocation

The types of goals to which you would want to apply asset allocation are often longer term (and more expensive) than saving for next year's vacation. For example:

Retirement
College education for children
A vacation home
Purchasing or starting a business

Life events

Life events can dramatically change your needs and investment goals. You may want to revisit your asset allocation strategy after the following types of events:

Marriage
Divorce
A new child
A serious or chronic illness
Loss of a job
A dependent parent
An inheritance

Time to reach your goal

In general, the closer you are to your goals, the more conservative your asset allocation strategy should be.

The Newport Group recommends the following time-horizons for their model portfolios:

Less than 3 years Low risk

3-5 years Medium risk

More than 5 years High risk

Amount needed to reach your goal

If you need a lot of money to attain your goal, you may need to target a higher potential return.

Similarly, if you almost have enough money for your goal, you can use a less-risky asset allocation strategy.

Often, the amount of money you need is large (suggesting a more aggressive asset allocation strategy), but the time to your goal is short (suggesting a less-risky asset allocation). There is no easy way out of this situation, but a financial advisor may be helpful.

Risk tolerance

This is a critical factor in any asset allocation decision. How bold or cautious you want to be comes down to what you might call the "stomach test." How comfortable are you with the ups and downs of different financial markets?

It helps to use numbers to visualize the risk. For example, The Newport Group's model high-risk portfolio with an expected long-term return of 8.5% has a standard devation of 14.50%. This means that roughly two out of three years you could expect returns to be anywhere from -0.06% to 23.00%.

On the other hand, The Newport Group's low-risk model portfolio with an expected long-term return of 5.0% has a standard deviation of 5.06%. That means that roughly two out of three years you could expect returns to be anywhere from -0.06% to 10.06%.

Income stability

You may want a higher risk target allocation if:

Your income is solid and likely to improve over time.
You have a dual-income household.
You have the option (and are willing) to work more.
You will have a steady stream of income during retirement (from a pension and Social Security, for example).

You may want a more conservative target allocation if:

Your income is erratic or shaky.
You don't have the option (or are unwilling) to work more.

Taxes

If you are in a high income-tax bracket:

Consider asset classes that return more from long-term increases in value (capital gains) than from interest or dividend income. Capital gains might be taxed at only 20 percent, but interest or dividend income is taxed as high as 39.6 percent.
Consider targeting a higher rate of return (which would have a higher risk), since taxes will eat away a larger portion of dollars earned.
Consider tax-free municipal bonds. The income from a tax-free bond might be higher than the after-tax income on a taxable bond.

If you are in a low income-tax bracket:

Tax-free municipal bonds may not be the best investment alternative. You can usually get a higher return from taxable investments of similar quality and yield.