1. Keep five years of uncovered expenses in cash. This doesn’t mean five years of totalexpenses, just the amount you withdraw from your savings to cover your ongoing costs. For example, if you spend $4,000 a month, and Social Security and a pension together bring in $3,000 a month, that’s $1,000 a month that’s not covered, or $12,000 a year. So keep $60,000 of your retirement nest egg in cash or cash equivalents such as a savings account or money market fund. That way, no matter what happens to the economy or the stock market, you won’t be forced to sell out at the worst time.
Most retirees made their money through work, saving and investing. The main goal now is not to grow your nest egg, but to preserve it and live off the proceeds. So with that in mind, here are five guidelines for investing a retirement portfolio.
2. Become more conservative. An Employee Benefit Research Institute report found that just before the 2008 financial crisis some 40 percent of 401(k) participants between ages 56 and 65 had over 70 percent of their account in stocks. This is too much risk for people approaching retirement, and many of these near retirees or early retirees lost almost half their nest egg. An old rule of thumb suggests a stock weighting equivalent to 100 minus your age. So at age 60 you should have 40 percent in stocks, not 70 percent. At age 80, it’s 20 percent. This approach decreases your risk as you get older, yet still gives you room for growth and some protection against inflation. It also matters what stocks you own. As you age, you likely want fewer high flying internet or biotechnology stocks and more utility and large-cap stocks that tend to be less volatile and pay higher dividends. There’s even less risk if your choose exchange-traded funds or mutual funds that focus on these securities instead of the individual stocks themselves.
3. The more income you have, the more risk you can take. If you have a secure pension, or waited until age 69 or 70 to start collecting Social Security for the higher monthly benefits, then you might have enough income to cover 80 percent or more of your normal expenses. If that’s the case, according to the “Spend Safely in Retirement Strategy” from Stanford University, you can afford to take more risk with your investments, keeping more money in stocks and reaching for higher growth. You might need that growth for the future since we are increasingly living longer lives.
4. Be careful about bonds. As a general rule, the older you are, the more money you want in bonds. But there are two problems. In recent years, both government and corporate bonds have produced paltry interest payments. Bonds or bond funds that generate only 2 or 3 percent yield are simply not very good investments. The other issue: Bonds have also become more volatile, and are not as safe as they once were. If interest rates rise as predicted, your bonds will lose value. Of course, bonds always have some place in a retirement portfolio. But these days that allocation should probably be smaller than in the past, and favor short-term instruments, which tend to better hold value as interest rates go up.
5. Keep it simple. Aim to to gradually shift to a more conservative portfolio over time, so you don’t find yourself with so much risk that a market downturn could force you to postpone retirement or dramatically scale back your living standard. Rebalancing your portfolio once each year is typically all you need. The simplest way to diversify your retirement portfolio is to focus on just a few diversified funds, such as a total U.S. stock market, value-oriented ETF or mutual fund, a mid- or short-term U.S. bond market index fund and perhaps a gradually decreasing allocation to an international stock index fund. This mix offers low costs, adequate diversification and, perhaps most importantly, keeps you out of trouble by avoiding the more esoteric and treacherous corners of the investment world.