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
This is a complicated answer. There really is no single allocation that is best for someone. It really will depend on your risk tolerance, risk capacity, and retirement income needs.
Risk tolerance describes your comfort level with investment variability (sometimes referred to as volatility and measured by standard deviation which you'll sometimes see listed in an investment fact sheet at Morningstar).
Risk capactity refers to your ability to take on risks after looking at the big picture of your finances. Example: You have a small nest eff and may have a high risk tolerance and willing to accept sharp ups and downs with your investments. But you lack an adequate emergency reserve account or are missing some other critical insurance coverage. In this case, you lack the capactity to take on lots of risk. Think of it in these terms: Your spirit is willing but the body is weak.
Finally, you have to consider what you need your investments to produce to support your lifestyle. There are rules of thumb (example:withdraw 4% of your total investments each year and it may last you 30 years in retirement). A better way is to factor in all that you'll need to cover your fixed overhead and discretionary (i.e. fun) cash needs. Make a best guess about your life expectancy or use online tools based on actuarial tables (see www.longevityillustrator.org). Then add up all your fixed or guaranteed income sources like pensions, Social Security, rent received. There will be a gap and that is what the investment portfolio needs to fill - preferably from gains, interest, and dividends. But if you're short, you'll probably need to take it out of the principal amounts you're investing.
All that being said, you should probably aim for setting aside a bucket into cash or near-cash investments (money markets, CDs, ultra short-term bonds) equal to a minmum of six months up to 3 years of fixed expenses. The exact amount will depend on your risk tolerance.
Then with your remaining investable resources you should aim for an amount in equities equal to about 115 minus the age of the youngest spouse. There's a general rule of thumb that says 100 minus age but with people living longer and insurance companies using life expectancy tables of 120, you'd be safer using a higher number. As uncomfortable as it may make you, the reality is that the best investments to counter the risk of inflation in retirement will be owning stocks (individually or through equity-focused mutual funds or Exchange Traded Funds).
With the balance you can allocate to fixed-income (bond funds, bond ETFs, or individual bonds).
Given low current interest rates, you may want to consider a higher allocation to equities. As the Fed increases rates, you're likely to see the price on existing bonds or bond funds go down (the price of bonds moves in the opposite direction of market interest rates). While there's no "safe" investment, you may find stocks or funds that invest in dividend-paying companies can be a lower risk option. These include "Steady Eddies" like utilties and large consumer product companies.
And if it's yield that you're looking for, you should consider adding an allocation to real estate-oriented funds.
For a more specific allocation tailored to your needs, consider reaching out to a qualified financial planner or investment adviser.
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.