According to the U.S. Census Bureau, more Americans are living until their 90s, or even until 100. That makes it even more crucial that retirees’ savings are invested to maximize the likelihood of the money lasting as long as they do.
As they age, investors should change their portfolio allocations to accommodate shrinking time horizons and changing goals. “Typically, as investors make that transition from accumulation phase to retirement, their risk tolerance tends to be more conservative,” said Ray Prospero, a chartered financial consultant at wealth advisory firm AdvicePeriod in Los Angeles, in an email.
“It’s important to have a systematic process in place to periodically review one’s goals, risk tolerance and time horizon, as well as overall portfolio performance,” he added.
Structuring Your Retirement Portfolio
Investors should take three main steps to structure their retirement portfolios, wrote Rob Williams, managing director of the Schwab Center for Financial Research in Lone Tree, Colorado, in a 2023 blog post.
1. Set aside one year’s worth of cash. This money, stashed away in a liquid account rather than in stocks or bonds, can ease worries about market fluctuations. This fund should be replenished throughout the year.
2. Create a short-term reserve. This next bucket of money should be equivalent to two to four years of spending, Williams says. This money can be invested in fixed-income instruments, which are less risky than stocks. Bonds and short-term certificates of deposit could also be suitable investments.
3. Invest the rest of your portfolio. Now it’s time to allocate your portfolio in a manner aligned with your own goals, time horizon and risk tolerance. For example, if you’re in your 60s and preparing to retire at age 70, you can take more risk in the form of stocks than someone older and already retired.
Over time, the proportion of more volatile stocks generally shrinks relative to the proportion of less risky fixed-income securities.
[READ: Is a 60/40 Portfolio Appropriate for Retirees?]
Balancing and Allocating Your Portfolio
Many investors mistakenly believe higher risk tolerance is somehow a badge of honor when, in reality, risk tolerance is related to other factors, such as goals and time horizon.
The first step in portfolio allocation is determining your goals, said Dan Kieffer, director of asset allocation at UMB Bank in Union, Kentucky, in an email. That’s important for self-directed investors as well as those working with an advisor.
“Well-defined goals enable your team to determine the required rates of return to meet them,” Kieffer said.
Your goals may include building wealth, saving for your kids’ college, planning your retirement, preserving your assets or creating a legacy plan.
“In your personalized strategy, you might see options to invest in stocks, bonds, real assets and alternatives,” Kieffer said. “These all serve a different purpose and will be selected to complement each other and the different fluctuations that can occur across asset classes.”
[READ: Should Retirees Follow the 100-Minus-Your-Age Rule for Stock Allocation?]
Navigating Asset Allocation Challenges in Retirement Accounts
Self-directed investors, in particular, should understand the implications of various investments and their effects on a portfolio.
“There’s no ‘one right way’ to invest assets in a retirement account,” said Katherine Silk, founder at Strategic Startup Advisors in Cambridge, Massachusetts, in an email.
Investors may want to check that they are not over-invested in U.S. stocks, Silk said. That’s a common mistake known as home-country bias. It’s already likely that U.S. investors will have other assets, such as their homes, personal networks, education and skill sets tied to the U.S.
In addition, investors should avoid emotionally driven portfolio decisions. This is often a tough guideline to follow, as daily headlines and market fluctuations often cause investors to panic.
“Try to avoid making allocation decisions during times of market distress,” said James Enriquez, financial advisor at Strategic Insights Financial Planning Group in McAllen, Texas, in an email.
That usually leads to underperformance, Enriquez said.
“If, however, you cannot avoid this, perform a retirement projection to see if you can still meet your retirement goals with a lower return, conservative portfolio,” he said. That would reduce risk in your portfolio and minimize the impact of emotional trading.
[READ: 10 Strategies for Investing After Retirement]
Monitoring Your Allocations for Long-Term Retirement Success
Once a portfolio is allocated, it’s not a one-and-done activity. Instead, investors have to monitor their holdings regularly to be sure the portfolio remains aligned with their predetermined allocations.
For example, say you’ve determined that a 50% allocation into stocks is optimal for your particular goals, risk tolerance and time horizon. After a few months, the equity portion of your portfolio has risen to 65%.
In this case, to get your portfolio aligned again, you’d pare the equity position back to 50% and buy other financial products, such as fixed-income investments, to restore your allocations to their original levels.
Another crucial part of monitoring your allocation is to avoid panic selling.
“If history is any guide to the future, we know that a portfolio, even a well-invested portfolio, will experience ups and downs,” Silk said.
“It’s natural to panic when your portfolio decreases by 10%, but if you, or your advisor, has chosen your assets well, you should have the confidence to stay invested,” she noted.
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How to Build a Balanced Retirement Portfolio originally appeared on usnews.com
