Wall Street has grown complacent. Prudent investors should actually show greater worry these days, amid mounting risks at home and overseas. As I’ll explain below, proper portfolio allocation is more important now than ever. I’ll show you how to tailor your allocations to your specific investment needs.

But first, let’s look at the recent outbreak of bullishness and what it all means for individual investors.

Wall Street hit a couple of milestones last week: both on Tuesday and again on Friday, the S&P 500 index and Nasdaq composite hit new highs. The Dow Jones Industrial Average also has been on a tear and flirts with new highs.

These bursts of buying occur as investors weigh conflicting signals. Corporate earnings have been a mixed bag so far, with some blue chips surprising on the upside and others missing expectations.

Regardless, the overall consensus projection for earnings growth this season is for a year-over-year decline of 3.9%. If that prediction holds true, it would represent the first negative earnings quarter since the second quarter of 2016. That’s a far cry from the 25% earnings growth that the S&P 500 racked up in the first quarter of 2018.

On the positive side, the Commerce Department reported last Friday that U.S. gross domestic product grew at a robust 3.2% annual rate in the first quarter, greater than expected. Other reasons for optimism include a hands-off Federal Reserve, upward momentum in small-cap stocks (typically a bullish indicator), and ostensible progress toward a trade deal between the U.S. and China.

Indeed, the overall sense of gloom that hung over the global economy earlier this year is starting to dissipate. China’s economy is showing greater growth than expected, U.S. retail sales have been healthy, Europe’s battered manufacturing sector is rebounding, commodity prices are rising, and inflation seems subdued. But the sense of prosperity is tenuous and it wouldn’t take much bad news to send investors into a funk again.

Stimulus from the U.S. tax overhaul is fading, the massive federal deficit will prove an economic albatross, corporate debt hovers at alarming levels, and anyone who thinks the trade war will just go away is deluding themselves.

Rising oil prices benefit the energy patch and also lift the broader stock market. However, threats to supply — whether in Iran, Venezuela, or Libya — are proliferating and crude could rise too far, too fast. An oil-price shock, which remains a possibility, would torpedo a still vulnerable world economy.

Then there’s the political chaos in Washington, DC, with a looming Constitutional crisis and increasing impetus to impeach the president of the United States. Wall Street hates uncertainty and there’s plenty of it around.

That’s only a partial list of the dangers lurking for investors. Today’s investment environment demands that you pursue “defensive growth.” If you get too cautious, you’ll be leaving money on the table. But if you start rolling the dice on risky growth stocks, you’re likely to get burned in the next big sell-off (which is likely to occur this year).

You can batten down the hatches now, by making sure the assets in your portfolio are properly allocated.

Tap The Power of Asset Allocation

Asset allocation is an art as well as a science. It’s the investment alchemy whereby you balance several ingredients for the proper admixture of risk and reward.

An asset allocation policy entails dividing a portfolio’s investments among different asset classes. The most common classes are stocks, bonds, cash and cash equivalents, and hedges (precious metals such as gold and silver; inflation-protected exchange-traded funds; etc).

Your asset allocation plan should govern your choices when purchasing investments. It also should be designed to provide an easy and transparent way for you to determine how your investments are performing.

Asset allocation is one of the most crucial decisions in investing. Investors generate returns through three basic activities: selecting specific investments to buy; deciding when to get in and out of the markets; and establishing asset allocation.

The first two activities are the hardest and least forgiving. However, asset allocation is the easiest to determine — and it wields the most power.

According to financial industry studies, up to 75% of portfolio performance is related to asset allocation.

Of course, in a bull market, your allocation should emphasize stocks. In a bear market, you should lighten up on stocks in favor of bonds and cash. And for a transitional market that’s “in between,” you should strike a balance.

Your Allocation Checklist

Before establishing your portfolio’s asset allocation, first answer these questions:

• What’s the purpose of your portfolio?

Define your portfolio’s purpose. Here are some examples: to reap a lot of money over the short term, so you can make a big purchase such as a house; to generate reliable, future cash flow in retirement; to grow the family estate for your kids and grandkids; to set aside ample cash reserves for entrepreneurial investment opportunities; etc.

• What’s your stage in life?

For example: relative youth (aggressive growth); middle age (moderately aggressive); retirement in the next 10 years (income and moderately conservative); retired (stability and income).

There are several variations. Chose a category based not only on your approximate age, but also on your tolerance for risk. As long-term market history amply shows, you’ll have to withstand a lot of bumps along the way.

• How much wealth do you already have?

What’s your current net worth and how close is it to your ultimate goal? Do you already have a head start, which allows you to shoulder more risk, or are you starting from scratch?

• What’s your self-imposed requirement for a minimum rate of return?

Do you want to reap at least 10% a year? Do you want to at least equal — or beat — the S&P 500? The younger your age, the higher you can set your goals. But be realistic.

• What’s your risk tolerance?

If your portfolio takes a sharp turn for the worse when you’re in your 40s, you still have plenty of time to bounce back. But if your investments take a nosedive while you’re, say 65, you’re in a far worse predicament.

• Will your financial situation likely get better, deteriorate, or stay the same?

Are you securely ensconced in a paying job that will remain steady for the next few decades? Are you about to retire? Are you afraid of getting laid off?

• Will there be any withdrawals?

If you plan to start taking out money, how much will you withdraw and when?

• What are the regulatory requirements?

Don’t be blindsided by unforeseen rules and regulations. If your portfolio is an Individual Retirement Account (IRA) or 401(k), what are the mandatory distribution requirements?

Considering today’s investment conditions, here’s a guide to asset allocation that strikes the right balance, generally speaking. You should tweak the percentages depicted in this pie chart, depending on your answers to the above questions:

Not a Panacea

Many investors are becoming enamored with asset-allocation mutual funds, also known as “target date” funds, which try to provide investors with portfolio allocations predicated on their age, risk tolerance and investment objectives. However, even this “solution” can be too standardized and doesn’t address highly individual requirements.

According to the financial research firm Ibbotson Associates, about a half-trillion dollars are now invested in target date funds. Target date funds are simple to use — you pick the target date fund that will “mature” closest to your designated retirement date.

These funds are typically issued in five-year increments — 2010, 2025, 2030, 2035, etc. As the target date approaches, the fund’s allocation grows more conservative. The exposure to equities is diminished as the allocation to bonds and cash increases, reducing risk and volatility.

Target date funds would seem to be the perfect solution to the challenge of asset allocation, but there are no panaceas when it comes to investing.

It’s never advisable to put your investments on automatic pilot. One problem with target date funds is that their allocations are based on past returns, without accounting for the current market environment. Many also entail high expense burdens.

There’s no substitute for doing your own homework. As you determine asset allocation, stay focused on the long-term big picture, not the market’s quarter-to-quarter roller coaster rides. Put temporary market blips into perspective. Case in point: the market swooned in the fourth quarter of 2018 but it has since regained its losses and then some.

Questions about asset allocation? Drop me a line: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.