With the recent stock market decline, now would be a great time to review your current asset mix and perhaps rebalance back to your long-term target weights.
Asset mix is how you divide your retirement savings between different investment assets. The three major asset types are:
1. Equities such as stocks
2. Fixed-income investments such as bonds
3. Cash or cash-equivalents, like T-Bills
Equities typically provide higher returns than cash or bonds, but also tend to fluctuate more in value. Bonds and cash usually provide lower, but more consistent returns.
How you balance your RSP between these three asset classes largely determines what sort of returns you can expect and also what level of risk your savings will be exposed to.
Setting the right asset mix for you
Everyone has an ideal asset mix based on factors such as their retirement goals, tolerance for investment risk, and stage in life.
Building your RSP: In the first stages of saving for your retirement, your RSP would most likely benefit from having a larger percentage of stocks since time is on your side. Over longer time periods - say 10 or 20 years - stocks tend to provide higher returns compared to bonds and cash and the short-term fluctuations in value smooth out.
Managing your RSP. As you approach retirement, it becomes increasingly important to begin securing profits and protecting your savings. At this stage, your RSP would most likely benefit from a more even asset allocation between stocks and bonds.
Enjoying your success. Once you are retired, your focus shifts to maximizing your retirement income. You need to convert your RSP into an income source by the year in which you turn 71, such as a Registered Retirement Income Fund (RIF) or an annuity. If you choose a RIF, you will be able set your asset mix as you did with your RSP.
At this stage, it generally makes sense to allocate more of your savings to more secure, income-producing investments such as bonds. However, you still need a certain allocation of stocks to provide some long-term growth - with today's longer life expectancies, you can expect to live another 20 years once you reach age 65.
Advantages of asset allocation
Greater long-term growth potential. When people are just starting to build their retirement savings, they don't always set the right asset mix. By implementing the right asset allocation for your RSP early on, when time is on your side, you can benefit from the greater long-term growth potential offered by stocks.
Reduced risk. By diversifying your investments between all three asset classes, you can reduce the risks associated with having `all your eggs in one basket.` For example, if the stock markets go down, the bond markets might go up.
A wider range of opportunities. Through asset allocation, you can take advantage of opportunities that may not be a suitable match to your objectives and investment style on their own. For example, it may be too risky to invest all your savings in emerging markets or up-and-coming companies. But you could allocate some of your savings to these types of investments, while balancing out your RSP`s overall risk level with more secure investments.
Your RSP`s asset mix has a major impact not only on the returns you can expect from your retirement savings, but also the level of risk.
This article has been supplied by Colin MacAskill CFP CIM, a vice-president and an investment advisor with RBC Dominion Securities Inc., the wealth management arm of the Royal Bank. He can be reached on his direct line at 604-257-7455.
