We live in unusual times, with interest rates at historical lows but likely to rise in the not-too-distant future, stocks trading at what some consider elevated levels driven by a years-long bull market, and investors scouring the pronouncements of central banks for clues to what may happen next. However, one thing remains unchanged – those in or near retirement still have to map out a prudent strategy for generating income in the years ahead.
While a traditional approach relying primarily on bonds and other fixed income securities served those who retired during much of the past 30 years fairly well, different times call for different thinking. Some researchers and investment professionals now recommend that retirees maintain a significant allocation to equities throughout retirement, perhaps even increasing that allocation as they age.
The Case for Stocking Up on Equities
The foremost worry of many retirees is that they might outlive their money, so any retirement income plan must squarely address that risk. Holding a higher proportion of equities, which offer the possibility of capital appreciation, may help offset the steady drain on retirement portfolios caused by withdrawals and inflation. In addition, be aware that bonds as a whole may decline in price if interest rates trend upward over the course of a long retirement.
Think Ahead About Volatility
Equities historically have been more volatile than bonds, so if you allocate more of your retirement portfolio to stocks, you have to be prepared to weather periods of volatility. It’s critical that you work closely with your advisor to invest in a portfolio that fits your risk tolerance so you are able to stay the course when the inevitable gyrations arrive. Also, keep in mind that bonds can be volatile too, especially when interest rates rise. For balance, consider maintaining a cash reserve equal to several years’ worth of living expenses – you and your advisor can decide how much.
Consider All Your Income Sources
Comparing income to your overall expenses will provide you with a framework for determining how your retirement portfolio should be allocated. You and your advisor may be able to estimate how your portfolio will react in certain hypothetical circumstances and make adjustments as needed.
Time to Take a U-turn?
While gradually reducing exposure to equities over time to create a “glide path” has been a traditional approach where bond allocations reach their maximum when you retire, some experts now advocate for a “U-turn glide path.” This can help avoid a tough recovery from several years of negative returns at the outset of retirement.
The U-turn glide path:
Dial back your allocation to stocks as you approach retirement.
Leave the allocation at that level for a few years.
Raise the allocation as time goes by.
The potential benefit? It helps reduce the chances of incurring major losses at the beginning of retirement while also allowing for the possibility of capital gains later.
Next Steps
- Carefully monitor and manage your portfolio, including the amount you allocate to stocks, bonds and cash.
- Ask your advisor to review your portfolio to help determine if holding a higher proportion of equities may help offset withdrawals and inflation.
- Your advisor can guide you in structuring a prudent investment strategy that can carry you through retirement.
Past performance may not be indicative of future results. Asset allocation does not guarantee a profit nor protect against losses. Investing involves risk, including the possible loss of capital. There is no assurance any investment strategy will meet its goals or be profitable. Dividends are not guaranteed and will fluctuate. Material prepared by Raymond James for use by its financial advisors.
