Final answer:
Asset allocation shifts from growth-focused investments like stocks and mutual funds in mid life to more stable and income-generating investments like bonds and annuities as one nears retirement. This strategic change is to balance the need for long-term returns with the need for capital preservation and reliable income during retirement. Mitigating inflation effects and achieving a stable financial future are also important reasons for this shift.
Step-by-step explanation:
An asset allocation plan should evolve as an individual moves from mid life to retirement. In mid life, individuals may opt for a growth-oriented strategy, favoring investments in stock market and mutual funds due to their potential for higher returns over the long term. These types of investments, while volatile in the short term, can yield substantial growth over the course of decades, which is beneficial for someone who is several years away from retirement.
As individuals approach retirement, the focus typically shifts from growth to preservation of capital and income generation. This means reducing investment risk by reallocating assets into more stable investments such as bonds, annuities, or dividend-paying stocks. These investments tend to offer more predictable and steady income, which is crucial for retirees who need to fund their living expenses without the same level of income from employment. It is important to consider personal preferences and the desired lifestyle during retirement when adjusting one's investment strategy, ensuring that there will be adequate income to support a comfortable retirement.
Changes in asset allocation also help mitigate the effects of inflation, which can erode the purchasing power of savings over time. A well-diversified portfolio adjusted to reduce risk as one nears retirement can help provide a stable financial future, addressing the uncertainty of inflation and market volatility.