6 Best Practices for Asset Allocation in Retirement
If you’re close to retirement age or planning to retire early, it’s essential to think about the best way to handle your assets after retirement. In fact, one of the most common questions we hear from our Addition Financial members is this:
It’s an important topic because how you allocate your assets will have an impact on how long they last and how much you enjoy your retirement.
With that in mind, here are six best practices for asset allocation in retirement.
#1: Understand the Basic Principles of Asset Allocation
The first thing you need to do is grasp the basic principles of asset allocation. Your assets should be earning money for you, but you have options that include long-term and short-term investments.
A good rule of thumb is to subtract your current age from 110 to determine what percentage of your total assets should be in stocks. Stocks are riskier than bonds, but can also be far more profitable.
That means if you’re 50 years old, as much as 60% of your assets should be in stock. The remainder can be in short or long-term bonds.
#2: Invest (Nearly) Everything
As a rule, we don’t recommend keeping a lot of cash on hand. Your money should always be earning money, even when you’re retired.
Most savings account offer, at most, a low interest rate. Keeping your money in savings is unlikely to do much to increase your wealth. Of course, you’ll need enough cash on hand to cover your short-term expenses, including groceries, utilities and your rent or mortgage.
The remainder should be in a mix of stocks and bonds according to the formula in the first best practice. There are short-term bonds you can buy that are very low-risk and will earn you more interest than even the best savings account.
#3: Understand Your Risk Tolerance
We all react differently to risk. For some of us, there’s a real thrill associated with taking a risk, whether it means bungee jumping or investing in speculative stock. To ensure your retirement is enjoyable, you must understand your risk tolerance.
If you’re the kind of person who’s likely to peruse stock prices every day and worry if your holdings’ value dips, then you’ll be most comfortable with low-risk stocks. You may want to consider money market funds or dividend-paying stocks.
By contrast, a person with a high tolerance for risk may be willing to take chances in the hope of getting a big payoff in the future. If you fit this category, you can take chances on some riskier investments.
#4: Understand Your Risk Capacity
Some people confuse risk tolerance and risk capacity. Risk tolerance is about how risks make you feel. Risk capacity is about how much risk you can afford to take without altering your retirement plans.
You’ll need to think about a few things when evaluating your risk capacity. These include:
Your previous spending patterns and behavior
Your monthly and annual expenses
Your specific retirement plans (travel, etc.)
In other words, if you put a significant percentage of your assets into stocks and loose equity in the short-term, will you be able to enjoy your retirement, or will the losses require you to cut spending and change your plans?
#5: Consider Non-Portfolio Income Sources
Asset allocation means managing your portfolio to maximize your future earnings while still having enough to meet your expenses. Before you decide how to allocate your assets, you’ll need to understand where the money for expenses will come from.
It’s possible that your income from some sources may be enough for you to pay your expenses. Examples include:
If you can pay your monthly expenses with income from non-portfolio sources, then you can afford to take more risk with your asset allocation.
#6: Factor in Other Goals
Enjoying your retirement may not be your only financial goal. For many people, there’s also a desire to:
Leave money behind for their children
Pay for education or leave money to their grandchildren
If you have goals that aren’t specifically related to your retirement, you’ll need to take those into consideration as you allocate your assets. It can be tricky to figure out the best strategy to meet your goals, which is why you may want to consider meeting with a financial adviser to talk about what you hope to accomplish and the best way to do it.
Asset allocation in retirement requires careful consideration, assessment and planning. Even if you are years away from retirement, you can benefit from developing an investment strategy.
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