The general rule of asset allocation in retirement is this: you should move to more conservative investments when you retire, since you no longer have any active income to replace losses. However, you will need this money for decades, so you should not completely abandon your growth-oriented positions. And therefore find the exact balance according to your personal spending needs. Here are three steps to building your asset allocation for retirement in 2022.
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A financial advisor could help you create a financial plan for your retirement needs and goals.
1. Set your goals, then adjust them over time
When planning for retirement, it is important to anticipate two issues:
Life expectancy. According to OECD data, the average American aged 65 can expect to live another 18 to 20 years. However, retirees should not anticipate this number. A healthy American can often expect to live well into their 80s and 90s, and for people currently planning their retirement, there’s good reason to expect that will continue to stretch out.
If you’re retiring at age 65, it’s wise to plan for at least 30 years of money. More, if possible. This means that you will need a nest egg large enough to last for years. It also means that inflation should be an integral part of your planning. Even 2% (the Federal Reserve’s target inflation rate) can significantly reduce your savings when accumulated over decades.
Way of life. Retirees who want to travel and have adventures will need more money than those who want to fish and catch up on their favorite movies. If you have significant health care needs in your 65s, you’ll want to plan for more medical expenses than someone retiring in good health. Your needs and preferences in retirement will determine your expenses, which in turn will determine how you should plan your finances.
Together, your life expectancy and lifestyle will help you understand how you should structure your finances as you approach retirement. The earlier you retire, the more money you need to save for the future. Meanwhile, the more you plan to spend, the more money your account will need to generate.
This means that your needs will generally change as you retire, so your asset allocation should too. Your financial plan at age 65, when you may still have many years to come and the relative youth and health to spend more freely, will likely be very different from your asset allocation at age 85.
2. Allocate assets to manage your risk
The rule of thumb when it comes to managing your retirement portfolio is that you should be more aggressive sooner. The younger you are, the more time you have to make up for losses you incur on high-risk assets. Then, as you get older, you should shift money to more conservative assets. This will help protect you against risk when you have less time to get your money back.
As you enter retirement itself, you should be moving your assets in a generally conservative direction. This reflects the fact that you have no intention of working again, so you will have to make up for losses in your portfolio with future earnings and social security.
This is generally a sound strategy. The two most common low-risk assets for a retirement account are:
Bonds are debt securities of companies, or sometimes municipal governments. They generate a return based on the interest payments made by the borrowing entity. Most bonds tend to be relatively safe investment products, since large institutions usually pay their debts (and have assets to recover if they don’t).
Certificates of deposit are low-risk, low-return products offered by banks. You make a deposit with the bank and agree not to withdraw it for a minimum period. In return, they pay you a higher than normal interest rate.
Bonds and CDs are considered low risk assets. Bonds give you a better return but retain some element of risk, while CDs give you a fairly low return but with about as little risk as possible.
In fact, CDs are even lower risk than just holding your money in cash, because they generally pay interest rates that keep your money somewhat inflation-ary. (Although at the time of writing this is not the case due to high rates of inflation.)
For most retirees, investment advisors recommend low-risk asset allocations around the following proportions:
65 to 70 years old: 40% – 50% of your portfolio
Age 70 – 75: 50% – 60% of your portfolio
75 and over: 60% to 70% of your portfolio, with a focus on cash-like products like certificates of deposit
3. Plan your growth based on your spending needs
The most important test when deciding on the asset allocation of your retirement portfolio is how it will generate money versus how you plan to spend money.
Many retirement advisors recommend planning to replace about 75% of your income in retirement. In other words, if you currently earn and live on $100,000 a year, you should expect to need $75,000 a year in retirement. This gives you a number to test your retirement account.
When planning your portfolio’s asset allocation, how close do you get to that number? (Although remember that your retirement account does not have to replace everything of your income. Social Security will most likely contribute at least something to your retirement income.)
In an ideal scenario, your portfolio can reach the “replacement rate”. This means that your portfolio grows as quickly as you take money out of it. In theory, if you can reach the replacement rate with your money, you can live on your retirement savings indefinitely without ever dipping into your capital. However, that requires a fairly generous nest egg, and for most retirees that’s probably out of reach.
Either way, your portfolio will need an element of growth. If you have just retired, you will hopefully have many years of good health ahead of you. Twenty or thirty years is simply too long for your entire portfolio to languish on low-growth certificates of deposit, especially since many retirees will have to live off that account almost as long as they live. will have built.
Generally speaking, the two most recommended asset classes for growth-oriented portfolios are:
By shares, we mean the shares of individual companies that you own. These can be some of the most volatile assets in the market, which is both a good thing and a bad thing when it comes to returns.
Funds can include a wide range of options. Generally speaking, you will invest in mutual funds or ETFs. Some investors may seek aggressive, high-growth funds that seek to outperform the market as a whole. However, most investors will put their money in a standard index fund, usually indexed to the S&P 500.
The more money you keep in stocks, index funds and growth-oriented funds, the more your portfolio can grow during your retirement.
Although, again, this entirely depends on your individual needs, many retirement advisors recommend higher growth assets around the following proportions:
65 to 70 years old: 50% to 60% of your portfolio
Age 70 – 75: 40% to 50% of your portfolio, with fewer individual stocks and more funds to mitigate certain risks
75 and over: 30% to 40% of your portfolio, with as few individual stocks as possible and generally closer to 30% for most investors
While this is often a successful asset allocation, again build it according to your personal needs. Specifically, if you find that you can generate returns at or near your personal replacement rate with a more conservative portfolio, that’s usually wise. Your goal is to meet your financial needs with as little risk as possible.
The asset allocation in your portfolio doesn’t stop once you retire. You want a conservative portfolio overall in retirement, but with more growth-oriented assets in your 60s and early 70s.
Investment advice for retirement
A financial advisor can help you implement a financial plan for your retirement. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
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