Asset allocation matters in growing retirement savings

Asset allocation is one of the most difficult and yet most important decisions for investors. According to multiple studies, 40 to 90 percent of total return is driven by our asset weightings.

While the studies don't agree on the magnitude, stock and bond weightings clearly matter. I've met two memorable individuals over my career, each of whom took extreme positions in the allocation of their portfolio. One was invested entirely in stocks, the other completely committed to bonds. They were both retired. Both in their 80s. And one generated significantly greater levels of wealth.

Financial-services company TIAA-CREF conducted a 1998 study titled "Investing for a Distant Goal: Optimal Asset Allocation and Attitudes Toward Risk." Three experts were asked to provide asset-allocation ranges for individuals 40, 30, 10 and less than 10 years from their retirement goal. The study assumed the future retiree began with a zero balance and contributed $5,000 annually over 40 years with an objective of amassing $1 million by retirement.

The most surprising thing about the experts' asset-allocation recommendations is how consistently they agreed that a healthy allocation to stocks is appropriate even as we approach our retirement goal. With 40 years to retirement, the three experts — Jane Bryant Quinn, Burton Malkiel and Jack Bogle (founder of Vanguard) — recommended, respectively: 100 percent allocation to stocks, 70 percent and 80 percent.

With less than 10 years to the retirement goal, Quinn still recommended an 80 percent allocation to stocks, Malkiel 50 percent and Bogle 70 percent. That means for investors in their mid- to late-50s who intend to retire at 62, the most conservative recommendation (according to the TIAA-CREF experts) suggests a minimum of 50 percent of retirement assets be invested in stocks.

Returns for each expert's portfolio over the entire 40 years assumed the historical average real return for stocks of 9.2 percent and 2.5 percent for treasury bonds (The return info is Ibbotson data.)

You may have guessed that the top-performing portfolio was Quinn's, which exceeded the $1 million retirement objective, generating approximately $1.5 million by the time of retirement. Bogle's portfolio came in at just under $1.2 million, with Malkiel's at $860,000.

A portfolio solely invested in bonds grew to $350,000. Of course, the analysis is static, assuming an average historical rate of return. If you retired in 2008 when the stock market declined more than 30 percent, your portfolio experienced real and significant losses.

Still, the study is instructive. It causes us to examine our risk tolerance. And to confront the fact that stocks perform better than just about any other asset class over the long term. From 1926-2010, the S&P 500 has generated positive returns in more than 70 percent of the years.

Consider your allocations carefully. Investing is not necessarily the risky activity — it's the not investing that may result in the greatest risk.

Next week: The Great Retirement Expense.

Nancy Tengler spent two decades as a professional investor. She is an author, financial-news commentator and university professor. Her book "The Women's Guide to Successful Investing" is out. Reach her at nancy.tengler@cox.net.