Asset allocation–An overview
The combination of stocks and bonds in your retirement account is known as your “asset allocation.” An example of an asset allocation would be 50% stocks and 50% bonds, or 70% stocks and 30% bonds, or any combination thereof.
A good way to think about different asset allocations is in terms of the risk they carry. When we talk about “risk” in the world of investments, we are fundamentally referring to how much a given investment changes in value over time. Some asset allocations can carry more risk than others (such as 100% equity), meaning they are more prone to shift up or down in value, but they may provide a better return over time. Other asset allocations may be more stable and less prone to large swings in value, but they might not grow in value very quickly. Since your needs will change over time (especially as you transition into retirement), your asset allocation will need to change as well.
Many mid-career investors prefer riskier asset allocations that frequently shift in value, but have the potential to grow their account value substantially while they have noninvestment income. They may then transition to more conservative allocations as they get closer to retirement.
Target date funds
A common way of pursuing this strategy is investing in a “target date fund,” which will transition your asset allocation from risky to conservative as you approach retirement.
A feature of target date funds is “auto-balancing,” which just means that as different stocks and bonds within your account change in value, potentially tilting your allocation toward stocks or bonds, the fund will automatically buy and sell them as necessary to maintain the appropriate asset allocation (risky or conservative) for that point in time. You don’t have to do any work, since it’s all done for you with auto-balancing.