Understanding Asset Allocation in Retirement

There’s a maxim that’s rings pretty true in the retirement planning arena. It’s harder to manage your money in retirement than earning and saving it in the first place. Once you retire, you are most often at the mercy of the financial markets for your future returns for both income and growth from your retirement savings. Rising prices can eat into your standard of living. Also, mistakes in retirement are much more difficult to recover from or correct.

Money goals in retirement should be
1. Preserve Capital
2. Diversify Risk and
3. Generate income.

The first two set you up to enjoy the third. Asset allocation is all about diversifying risk and usually the first decision in the retirement planning process when your portfolio is being structured. Simply stated, it involves deciding on the appropriate mix of stocks, bonds and cash. This allocation will normally be set for a number of years and depends on your age and other factors agreed to between you and your advisor.

We all know that keeping all of your money in cash is safer than keeping it all in the stock market, but how do we quantify and measure this? The answer: re-visit history. Over long time periods, stocks, bonds and cash can be measured and molded into portfolios with fairly predicable outcomes. For illustration purposes, let’s assume a portfolio of 50% stocks and 50% bonds and a retirement lasting 20 years. Since stocks gain an average of 10% per year in total return, and bonds gain about 5%, your portfolio has a good chance of growing 7.5% per year. Now how does that compare with your withdrawals needed for income to live? In the moderate risk portfolio described, taking out 4% per year will almost guarantee you will never run out of money in 20 years of retirement. If you take out 6%, you have a 1 in 4 chance of running out of money. By changing the asset allocation, you can ratchet up or down the level of risk. More stocks – more risk year to year, but a bigger account over time. More bonds, less risk, a smoother ride but a greater chance of running dry. It’s a balancing act for sure.

When you are watching the evening news, hearing that the stock market is at a new high, remember that this allocation is 100% stocks, no bonds, no cash. With the tremendous roller coaster ride so far this century in the stock market, down 40%, then up 65%, perhaps a financial review is in order with asset allocation at the top of the agenda.