What allocation strategy do you recommend for those approaching retirement?
Me and my spouse are approaching retirement; how should we allocate our investments so that we can protect some and grow some?
The strategy is relatively simple in theory and somewhat complex in its execution. The key is to understand that you have very few years left to make up for a mistake. The question as you enter retirement is how much risk can you afford to take. If you lose $50,000 or $100,0000 in the stock market, do you have the earnings and/or wherewithal to replace it as you might've if you made a mistake at age 45 or 50? The key is to lessen your exposure to the equity markets prior to your formal retirement date. In today's economic environment and I'm assuming you've been extremely fortunate as we've had a positive equity market for the past eight and half years and just about everybody who's been in the market has done reasonably well, some more so than others. Take some of these gains off the table and move them into fixed-income. Unfortunately, fixed-income is not very attractive today as bank savings account are paying about 1% and even quality stocks are paying 2 1/2 to 3%. However, keep in mind how high the stock prices are and how quickly they could fall as even the best of the equity investments will fall when the general market is tanking. In other words consider at a bare minimum, a 60%/40% allocation to equity and fixed income and as you age, you may want to begin moving to 50-50 and then 40% 60%. Be very careful that you're not caught up in the crowd that says "this time is different ". It's never different in the market will fall and at some point it will recover. I hope this helps and good luck
The answer depends heavily on (1) the dollar size of your investments; and (2) the amount you will need to take every year in retirement. First, count up all the money you are sure you will get from sources other than your liquid investments. This could include rent from real estate you own; money from any part time work you might do; Social Security for both of you; and traditional pension income, if any. Then, count up everything you plan to spend in retirement. This does not mean just your basic food, shelter, utilities, insurance, etc. Count up everything that you need or want to have a pleasant and fulfilling retirement -- travel, entertainment, gifts, recreation. Don't forget taxes on dividends and interest as well as IRA distributions. Then, subtract your outside income from your total annual budget and you will get a number that represents the amount you will need to take from your liquid investments each year. I usually advise that retirees keep 2-3 years of living needs aside in something relatively low-risk and income-generating (I like preferred stocks -- contact me if you have questions) and invest the rest for the long term, in equities.
You say you are "approaching retirement." That means you are still gainfully employed and (I presume) able to add to your savings regularly at the moment. Keep at it. You need liquid investments totaling roughly 20 times your annual living needs (net of SS and other steady income sources). If you are past that point, you are in good shape and don't need so much in the bond market. Bonds as a rule produce zero returns after taxes and inflation, so they are merely a parking place for money you might need in a market downturn (because you don't want to have to sell at the wrong time.)
The weighted allocation guidelines I use are based largely on age. An example might be, a person age 60 would have equity exposure of 40%.
Age 70 would have equity exposure of 30%. Individual situations alter this rather basic allocation. If one has a pension, social security or inheritance. You might tilt a little more toward equities.
These are the considerations we take into account when managing portfolios.
Moving to a more conservative allocation is prudent as you near retirement so you can better weather a market downturn. However, fighting inflation is also important if you want to stretch your principal. Depending on your goals and time horizon, you can split your allocation between stock and bond funds. An ETF portfolio with an appropriate ratio is a great way to diversify risk and can be managed by a trustworthy financial advisor.
The first step to investing is to know yourself and then to have a plan. Knowing yourself means knowing your current financial situation (Set aside money for emergencies and reconcile your cash flows) and your risk profile (Ability and willingness to take risk). Planning involves making your life comfortable for the present and the future within your means. Once you have this in place invest for the long term.
You will have to forecast your expected income (Social security, pension, other sources) and your expected expenses in retirement. If your expenses are covered by your income, then you only must have set aside some money for emergencies and invest the rest for the long term. If not, your portfolio will have to account for the fact that it will have to generate income towards your expenses.
Expenses should be best covered by cash and other stable assets. I recommend having 24 months of your expenses that is not met by your income in highly liquid and stable investments. You can use a mix of cash and other short duration, high quality fixed income. Make sure you also have some cushion for emergencies.
The rest of the portfolio can then be constructed for higher long-term growth with some income that can then be used for your expenses beyond 24 months. You can use a portfolio of stocks, including dividend paying stocks diversified across industry, size and geography.
Portfolio construction really depends on your beliefs, ability and how much time you want to or can spend (In addition to your risk profile). You could have a broad allocation to the above asset classes and simply rebalance (I recommend yearly and if there has been a 5% or more deviation in allocations) or you may want to supplement the broad allocation with 'tactical tilts' depending on your views on the market.