MAY 13, 2016
How big should your stock allocation be when you retire? The financial industry has devoted much intellectual muscle to the search for an “ideal” allocation. Unfortunately, there is no one-size-fits-all solution.
The case for stocks is pretty straightforward: Historically, they’ve been one of the best sources of growth and returns. But they’re riskier than other investments. The success of your retirement plan depends in part on how you balance these qualities. On one hand, your portfolio needs to continue growing even after you retire so you don’t outlive your savings. On the other, you don’t want to endanger your savings by taking unnecessary risks.
So the “right” amount of stocks really comes down to your individual needs and preferences, which we’ll explore in more detail below. And what makes sense at the beginning of retirement may not make sense later on, so you will need to make adjustments over time.
“You don’t need all of the money for your retirement on the day you retire. Your portfolio should continue to grow over the years,” says Rob Williams, Managing Director of Income Planning at the Schwab Center for Financial Research. “What’s important is that you have the right balance at the beginning of retirement.”
So how do you strike that balance? That depends on a few things.
What’s in your portfolio?
For most investors, stocks should account for anywhere from 40% to 60% of their portfolios in the years just prior to and after retirement, with the rest invested in bonds and cash.
Where you fall on that range depends on factors including your risk tolerance, wealth, how much you expect to rely on your portfolio for income, and your anticipated longevity.
For example, if you have a long time horizon, are more risk tolerant and worry your savings will fall short, you might aim for a stock allocation of 60% when you retire. If you have a shorter time horizon, adequate savings and are less comfortable with risk, you might fall closer to the 40% end of the spectrum. What’s important is that your portfolio is geared to go the distance.
“You may retire, but your portfolio shouldn’t retire with you,” Rob says. “Your portfolio should continue growing over the course of your retirement.”
Once you’ve set your allocation, you will generally need to adjust it over the next 15 to 20 years by reducing your risk as you shift from saving to stability. The diagrams below show one approach to managing this transition.
A portfolio for all seasons
With an appropriately balanced allocation, you should be ready for whatever the market throws your way. This is important: How the markets are doing at the start of your retirement can have an impact that lasts for years.
If you retire during a bull market, congratulations. Your portfolio could get an extra boost that will add to your savings and give you a little more freedom in your spending plans.
But what about a bear market? This is where the value of good planning is most obvious, as a well-structured portfolio can provide some cushion to help manage market risk.
The key is to minimize a phenomenon known as sequence-of-returns risk. Basically, this refers to the possibility that your savings could be permanently damaged if you start withdrawing from your retirement account at the same time that it’s losing value. Selling assets when prices are down often means you burn through them faster—and that leaves you with little fuel to drive growth if markets recover. If the decline is steep or lasts a while, that could make it even harder to make up lost ground.
To help protect yourself against sequence-of-returns risk, you could consider using a “bucketing” approach. It works like this:
Bucket one: Set aside enough cash to cover your spending needs, after nonportfolio income sources like Social Security or a pension, for the next 12 months. In other words, if your plan is to withdraw $40,000 a year from your portfolio, you would keep that entire amount in your cash bucket. Treat this money as “spent.”
Bucket two: Put another two to four years’ worth of cash into assets that can be liquidated if needed. For example, if we stick with the $40,000-a-year plan, you’d put $80,000–$160,000 in easily liquidated assets such as cash alternatives or short-term bonds.
Bucket three: This is where you’ll keep your stock allocation and other more aggressive investments.
The idea is that you should have enough cash or cash alternatives on hand to cover your expenses over the near term, while at the same time aiming to preserve your portfolio’s growth potential over the longer term. After all, over the past 50 years, it took the S&P 500® Index slightly more than three years, on average, to recover from a downturn, according to research from the Schwab Center for Financial Research.
“With several years’ worth of living expenses positioned in lower-volatility investments, like cash, cash alternatives and bonds, you can feel more comfortable taking on the risks that can help you get to your goals,” says Rob.
At the end of the day, your target allocation—that mix of stocks, bonds and other assets—should reflect your long-term priorities in retirement. You shouldn’t change it just because of a temporary setback in the market.
Making your portfolio last
The bottom line is that you’ll likely need at least some stocks throughout retirement for diversification and growth potential.
It also helps to stay flexible. Check on your portfolio regularly—say, once a year—to make sure it still fits with your plans. You can always adjust as needed.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, please consult with a qualified tax advisor, CPA, financial planner or investment manager.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.