You might be wondering what the right asset allocation is if you are retired now or getting ready to retire. In fact, this is the one of the most frequently asked question I get. The conventional wisdom is that as you get closer to retirement your portfolio should become more conservative and pull out of equity in favor of annuities and bonds. But are conservative investments really the best investments to make once you retire?
On the face of it, this might seem reasonable. The older you are, the less able you are to make up for huge drops in value. Also, as you age, you’ll become more dependent on your investments to provide the income you need to live on. So, as you become more dependent on your capital, some argue, you need to invest more conservatively. This way, you take less risk of losing your money and therefore, you safeguard your income better. There is truth in this argument.
But it does not mean that your money should mostly be invested in CDs, bonds and/or annuities just because you retire. Lower risk investments are great. They can reduce risk and provide stability over the short run. The problem is, once you retire, you’re still investing over the long run because you need your money to last at least as long as you do. Just because you retired doesn’t mean your money can.
Don’t get me wrong. If you can afford to invest conservatively and still not outlive your income, that’s fine. But what if you invest very conservatively in order to feel good now…but as a result, you run out of money too soon? I’m not saying you shouldn’t be more conservative. I’m saying you have to consider the pros and cons of each decision before you do anything.
What I’m saying is that you need to think about your end goal. If, for example, you want to maximize your retirement income for as long as possible, you have to first articulate that and then invest accordingly.
Think about how long you want your money to last – not how long you think you are going to last.
For example, if you are going to retire next year but plan on staying alive and retired for 25 years after than, your asset allocation should be that which provides the best return with the least risk based on a 25-year time horizon – not a one-year or a one-day time horizon.
As you get older, your investment horizon does indeed shrink. But people forget how long they might live and how long they need that money to work for them. They sometimes invest as if their investment time horizon is very very short when in fact it is much longer. And as your time horizon expands, you take on greater risk of running out of money if you invest too conservatively and fail to earn enough to keep up with inflation. Sadly, that’s exactly where ,most bonds and annuities fall short.
Bottom line? Enjoy your retirement date. Have a party. Knock yourself out. But don’t make the mistake of putting your investments out to pasture the day you stop working. That can be one of the worst possible investment mistakes you could make.
Are you going to change your asset mix once you retire? To what? Why?
Ronald Dodge says
Asset allocation is quite important, not only from Bonds/Cash vs Stocks, but also from the different types of stocks and the different industries. However, the one allocation I am remaining firm is 80% stocks to 20% bonds/cash once in retirement years with the last 10 years of employment moving in that direction.
Derrell Huff says
I am with Ronald. I am 68 and still have 80/20 split with equities to bonds. I have enough monthly income to cover all my expenses without having to touch my retirement accounts, so can enjoy the
higher income from the stocks, and not have to worry to much about asset allocation.
Barb Friedberg says
Hi Neil, Just remember, it’s really important to start investing (even just a bit) sooner rather than later. Choose a modest asset allocation to start and then adjust as you go along. Research shows that 90% of portfolio returns come from the asset allocation decision.
PS This is a great post, it’s going in my link round up next week!
Financial Samurai says
I think the right asset allocation is the key to everything. Picking consistent winners is a fools game in the long run.