How to Find the Perfect Asset Allocation for Your Retirement Accounts

You understand the importance of investing for your retirement.

But when you look at 401(k) materials, you get lost in all of the possibilities.

This article will help you assess your options, focusing on how stocks, bonds, and real estate can put you on the road to retirement. Finally, you will see how these asset classes can be mixed and matched to best suit your unique needs.

A comprehensive retirement strategy is beyond the scope of this article (or any other). That will require a lot of research and/or a series of conversations with a trusted financial advisor. 

But what you will get is an assessment of the variables that go into retirement planning. Some of these variables don’t get enough press but can have a major impact on your decision-making.

You will also be provided with relevant data, placed in its proper context. For example, this article will exclusively focus on real returns, which means returns after inflation. If your $100,000 account turns into $110,000 in 10 years, but inflation was 2% per year over that period, the purchasing power of your account decreased.

No bueno.

So without further ado, let’s explore the asset classes. Starting with the most prevalent retirement investment.


US stocks are the cornerstone of most 401(k)s due to their very attractive returns over the past 90+ years. Since its inception in 1926, the S&P 500 has delivered an annualized real return of better than 6.5%. 

Though the stock market has had major drawdowns (2000-2002, 2008, and 2020 are a few recent ones), it has been a very safe bet over 20+ year periods, a relevant timeline for retirement accounts.

Here’s the deal:

The problem with many articles recommending equities as a retirement vehicle is that they over emphasize the likelihood of past returns being an accurate predictor of future returns.

Yes, you’ll get that little disclaimer at the bottom of the article, saying something along the lines of “past returns are no guarantee of future results.” But the reader is often apt to dismiss that statement as legal mumbo jumbo after reading an article making the (specious) argument that 90+ years of 6.5% annualized real returns means that the next 20-40 years will look similar.

I’m here to tell you that nobody (myself included) knows how much the stock market will return over the next 20-40 years with any certainty. But it should be noted that the US experienced incredible growth in the 20th century. The Bureau of Economic Analysis has real GDP statistics dating back to 1930. From 1930 to 2000, the US had annualized real GDP growth of 3.54%. From 2001 to 2019, the US has had annualized real GDP growth of 1.99%.

It is true that past returns not predicting future performance also means that the lackluster GDP growth of the past 19 years doesn’t mean that GDP growth won’t pick up over the next 20-40 years. But we also have to consider that ~2% growth might be the norm during the 21st century and what that means for long-term equity returns.

Shaving a few points off historical 6.5% real returns is probably smart when projecting how much your equity investments will appreciate over the next 20-40 years. On a multi-decade timeline, a two or three percentage point difference can significantly reduce your projected retirement nest egg.

6.5% vs. 3.5% real returns on a $5,000 per year contribution for 30 years.

There are countless ways to buy stocks for your retirement accounts. Index funds are a type of mutual fund whose holdings mimic a particular index, such as the S&P 500 or Nasdaq. Index funds have extremely low annual costs because they don’t require the massive resources of an actively managed fund. And as Warren Buffet’s highly publicized bet proved, cheaper definitely does not mean worse in this case.

Out of the major indices, the S&P 500 is perhaps the best choice for retirement accounts. It tracks 500 large companies and provides good representation across various sectors. 

International stock funds offer a way to diversify your stock holdings, though they are more risky than US stocks. Also, an S&P 500 index fund already offers international exposure with its many multinationals.

Fixed Income

With the ultra-low interest rates we’ve seen over the past decade, it’s easy to forget that bonds have had quality returns over the long run. And if we’re talking about US government bonds, there is a very low risk of default. Long-term US government bonds have average returns of 5-6% since 1926, outpacing inflation by 2-3%. Sounds appealing, but today’s bond market provides historically low income for investors after decades of plummeting yields.

Source: Trading Economics

The two major risks with investing in US government bonds are increases in inflation and interest rates. These risks are especially relevant in our current climate because inflation and interest rates have been historically low since the financial crisis. Yields on 30-year Treasuries are currently less than 1.5%. That is much lower than the average inflation of a little under 3% over the past 94 years, and still lower than the 1.7% inflation over the past 10 years.

The current yields seem absurd at first glance, but there is logic behind them:

  • US Treasuries have unrivaled safety and liquidity
  • Long-term downtrend in interest rates and inflation around the world
  • Lower growth projections

For those of you who are dead set on including US Treasuries in your portfolio, it may be wise to limit yourself to Treasury Bills and Notes, which have maturities ranging from three months to ten years. Yes, the returns on these are even lower, but at least you wouldn’t be locking yourself into 30-year nominal returns of less than 1.5%.

US Treasuries aren’t the only game in town for fixed income investors, though. While interest rates are historically low in the US and abroad, US corporate debt and foreign government debt offer higher returns than US Treasuries. With that said, they come with higher risk and the rates are still much lower than in past decades.

Bonds have traditionally acted as an excellent hedge for stocks in retirement portfolios as a negatively correlated and less volatile asset class. But it’s difficult to allocate a large percentage of your retirement income to an asset that offers little upside. Luckily, there is another appealing asset class that allows you to diversify your retirement assets.

Real Estate

Investing in real estate is a phenomenal way to build long-term wealth and fund your retirement. However, if you don’t have the up-front capital, time, or inclination, a real estate investment can seem unrealistic.

But you don’t need to become a landlord to invest in real estate. Real Estate Investment Trusts (REITs) are companies that own, operate, or finance real estate. Apartments, self-storage facilities, and malls are a few examples of property-types held by REITs. And just like with stocks, it’s easy to buy low-cost REIT index funds that give you wide exposure to the sector. 

An S&P 500 index investor already has exposure to REITs as they make up a shade over 3% of the index.

Is that enough, or should you increase that exposure?

First, let’s take a look at the historical returns. I couldn’t find REIT return data going back to 1926 like the S&P 500, but the FTSE NAREIT All Equity REITs Index has return data going back to 1971. From 1971 to 2019, an investor would have attained annualized real returns of a little over 5.5%, trailing the S&P 500 by around one percentage point. Again, historical returns are far from a guarantee of future returns, but they show that REITs are capable of delivering impressive long-term returns.

REITs have had a mildly positive correlation to stocks, but tend to be less volatile than stocks. This lower volatility, coupled with the potential for continued high long-term returns, make them an attractive proposition for your retirement portfolio.

The above chart shows the real returns from $10,000 invested in the FTSE NAREIT All Equity REITs Index vs. the S&P 500, from the beginning of 1997 until 2019. While the REIT index lagged behind the S&P 500 during the last few years of the 1990s bull market, it actually delivered positive returns during the early 2000s bear market as the S&P 500 experienced big losses. 

Unsurprisingly, REITs plummeted during the 2008 recession. But their nearly identical performance to the S&P 500 during the bloodbath of 2008 and quick recovery are perhaps reasons for optimism; while the S&P 500 has exposure to many sectors, real estate was particularly hard-hit during the crisis.

If you’re still not convinced that REITs deserve a place in your retirement portfolio, let’s look at how their tax characteristics make them a perfect fit for a Roth IRA.

REITs don’t have to pay taxes at the corporate level, provided they return at least 90% of taxable income to shareholders as dividends each year, among other conditions. Although most stock dividends are qualified and thus taxed at an investor’s capital gains rate, REIT dividends are often subject to an investor’s (usually) higher ordinary income tax rate.

Roth IRAs allow investors to pay no taxes on their REIT dividends, which can make a massive difference in compounding returns.

A comprehensive exploration of retirement tax planning goes way beyond the scope of this article, but this is just one example to show how you can maximize your after-tax returns by purchasing the same assets in different accounts. It demonstrates the importance of talking to a financial advisor or doing your own research to create a broader strategy in this realm.

Asset Allocation

If you want to get creative with your retirement savings, you could look into other asset classes. Precious metals, cryptocurrencies, and annuities are a few examples.

But sticking to stocks, bonds, and REITS should be sufficient for most investors.

The long-cited rule of thumb for retirement allocation has been the “Rule of 100.” The rule states that an individual’s exposure to stocks should be a percentage equal to 100 minus their age, with the remainder allocated towards high-quality bonds and other safe assets. Adherents rebalance their portfolios as they age, and as differences in returns inevitably alter their allocations.

The logic is sound, as stocks often experience 10+ year periods of low (or sometimes even negative) real returns. Bonds can prop up your portfolio during lean times. And a 35 year-old can wait out stock market underperformance in a way that a 70 year-old retiree cannot.

The above chart shows how $1,000,000 invested in the S&P 500 at the beginning of the year 2000 was worth a little over $700,000 (in 2000 dollars) ten years later. A 70 year-old retiree with his accounts fully invested in the S&P 500 might have struggled to endure this decline. 

A portfolio with 40% 10-year US Treasuries, 20% REITs, and 40% stocks would have performed considerably better over the same period:

This portfolio would have been worth just over $1.3 million (in 2000 dollars) at the end of the ten year period. 

Yes, I’m cherry picking; 2000-2010 was a historically bad period for stocks, and yields were in the midst of their long-term decline (a boon for long-term Treasury investors).

But there are clear benefits to shifting your portfolio towards conservative assets as you age, and eventually retire.

Getting back to the 100 rule…

It certainly has its merits. But it’s an oversimplification of a complex decision. Even as a guideline, it pushes investors a little too far towards conservatism. With many people living into their 90s, an overly safe portfolio may not support you for all of your retirement years.

So, where does that leave you?

There is no one-size fits all formula for retirement allocation, but your decision will vary based on your answers to the following questions:

  • Do you have rental properties, a pension, or above-average Social Security benefits that would decrease your reliance on your retirement investments? Or are your retirement accounts going to be responsible for covering 80%+ of your living expenses?
  • Based on your contributions, what returns would you need to realize to attain your “number”?
  • Would you be able to handle watching your retirement accounts plunge 50% during a downturn without losing a lot of sleep?
  • Are you comfortable with the possibility that a riskier portfolio could require you to work for longer if the market has a protracted downturn? Or can you not stand the idea of working past a certain age?

We can’t go through every combination of answers to these questions, but to give you a sense of how the answers to these questions could impact your allocations, let’s consider two scenarios:

1. Jeff is a 45-year-old who owns three fully paid-off rental properties that cover 50% of his living expenses. He plans to work until he is 68 years-old and delay the onset of his Social Security, in return for a higher monthly payment. Jeff contributes the maximum allowable amount into his retirement accounts each year. With his real estate and Social Security income, he sees his retirement accounts as a way to treat himself during his golden years.

He was a nervous wreck during the 2008 financial crisis; he was 100% invested in stocks and endured countless sleepless nights as the value of his retirement accounts plummeted.

Based on this information, Jeff may want to allocate 70%+ of his capital towards US Treasuries and Triple-A rated corporate bonds. A 20-30% allocation split between stocks and REITs could be a way to increase projected returns in our low interest-rate environment, with a low likelihood of short-term pain.

2. Mary is a 37 year-old who just received a big promotion and 50% pay raise. She had only contributed small amounts to her retirement accounts in the past, but wants to contribute half of her pay raise from now on. She doesn’t own any rental property. While Mary hopes to retire in her early 60s, she loves her line of work and wouldn’t mind working a little longer.

Her favorite quote is, “this too shall pass” and she rarely gets rattled by short-term struggles.

This is less of a clear-cut case than Jeff’s situation, but Mary’s profile indicates that she may need high returns to meet her retirement goals. She also seems like she has the emotional fortitude to handle major drawdowns and can accept the retirement age risk factor. A 70% stocks, 20% REITs, and 10% bonds allocation might be appropriate for her.

Next Steps

Investing for your retirement is a little like cooking for yourself. You have the ingredients (stocks, bond, REITS, etc.) and you have to determine the right amount of each one. For you.

What’s too spicy for your friend might be just right for you…

Leaving the cooking metaphor behind, you should continue to familiarize yourself with the asset classes. Simulate a number of contribution and return combinations, if you are so inclined.

If/when you meet a financial advisor, you now have the knowledge to ask pointed questions and offer pushback if there are any dangerous assumptions (such as a near-guarantee of 6.5% annualized real returns from stocks over the next 40 years).

After all, it’s your retirement. If you’re not lucky enough to have a close friend or family member to advise you, it’s a necessity to make sure you’re not getting misled. 

Say you do have a trusted and (meticulous) financial advisor; a working knowledge, at minimum, remains necessary. This way, in the face of the next market downturn, you’ll have the confidence to stay the course.

And give yourself the best possible odds of achieving the retirement you want.

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