In a previous post we noted that the research on Gamma identifies 5 financial planning strategies that add to retirement income. The first of these is Total Wealth Asset Allocation. The simplest definition of this is using a client specific asset allocation strategy based on how much risk is appropriate rather than relying primarily on risk tolerance or a basic rule of thumb (60% stocks/40% bonds).
Morningstar goes on to say that, “Most techniques used to determine the asset allocation for a client are relatively subjective and focus primarily on risk preference (i.e., an investor’s aversion to risk) and ignore risk capacity (i.e., an investor’s ability to assume risk). In practice, however, we believe asset allocation should be based on a combination of risk preference and risk capacity, although primarily risk capacity.” The Gamma research cites the 2010 Survey of Consumer Finances which suggests that the average stock allocation for investors age 65-95 is only 20%. This may be overly conservative in many cases, leading retirees to lose pace with inflation and strain their long term income potential.
We agree with Morningstar that this is a very valuable part of the financial planning process. At Financial Symmetry, we have been using a similar strategy for over a decade with our Risk Capacity Model. This allows our financial planners to determine how much risk is appropriate for your investment accounts and design a strategy customized to your specific needs. Using such a model provides for keeping enough funds in conservative investments to meet your short term needs, while allowing other funds to be invested for the long term.
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