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Last week, Blueprint for Financial Prosperity wrote that he is liquidating his target retirement 2050 fund because of the recent volatility in the market. After re-reading his post, it appears that this was not his major retirement savings vehicle, but was instead a portion of his overall portfolio. In any case, his sudden withdrawal shows that he did not have an investment plan for this portion of his portfolio.

While I feel the same uneasiness that he has with the recent volatility in the stock and bond markets (see my comment in his post), the allocation of my investments was decided by asking myself a few simple questions.

1. How long until I need access to the money?

The longer the time horizon until you need to access the money, the riskier you can be with that money. In my case, I tend to have two types of investments. First, I use a liquid, short-term savings account from HSBC Direct for money I may need within the next year or two. Typically this is used for unplanned expenses such as automobile or home repairs or large, infrequent expenditures such as vacations. Second, I use illiquid, long-term retirement savings accounts for the money I won’t need for another 25-35 years (in my case). This money is invested primarily in stocks (approximately 90% at the moment) and is saved in retirement vehicles such as 401(k)s and Roth IRAs. The asset allocation will move away from stocks over time, but I won’t touch this money until retirement.

2. Would you panic if the value of your portfolio were to drop 20%+ in a short amount of time?

This is the question the gentleman I mentioned earlier failed to ask. If volatility in the market will cause you to cash out your investments, then you need to find something with less risk. You can stay with money market accounts, high-yield savings or CDs, or even mutual funds that are allocated according to your risk preference. Perhaps he would have been more comfortable in the Vanguard Target Retirement 2010 fund as it is currently only 55% stocks with 45% in bonds as compared to the Vanguard Target Retirement 2050 fund he cashed out that is 90% stocks and 10% bonds.

3. What large risks do you have such that you would have to pull money out of the account?

This question is a catch-all for the risks of needing a substantial amount of cash at some point. The major causes for needing cash are:

• Lack of insurance (health, property, life) when a disaster strikes
• Losing your job/source of income
• Divorce – leads to loss of assets and sometimes alimony and child support
• Lawsuits

If you feel you may be affected by any of the above, you will need to have more investments that are low risk and highly liquid in case of emergency.

With these three questions, you can properly allocate your money into investments that suit your risk profile. Check out this list of risk tolerance quizzes for a more in-depth analysis of your risk profile. Make sure you answer honestly!

UPDATE: Blueprint for Financial Prosperity wrote a follow-up post to this topic which gives more clarification on why he liquidated this investment.

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