How to Access the Right Asset Allocation for Your Retirement?
Maintaining the right asset allocation at retirement is one of the most important things to focus on. Your asset allocation should not only align with your risk appetite but also ensure that your portfolio is able to counter inflation and generate sufficient funds to support you throughout your retirement years. While you need to focus on growth, it is equally important to balance excessive volatility out, as you cannot take too much risk in retirement. Finding the perfect balance is essential.
A financial advisor can help you with retirement asset allocation to ensure a portfolio that aligns with your specific needs and goals.This article will also share some tips and practical strategies to help you determine the best asset allocation in retirement.
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Below are four tips that can help determine a suitable asset allocation for retirees:
1. Build up on bonds
Bonds provide the portfolio with the stability that it needs in retirement. Bonds deliver interest income, which is not as volatile as stock returns, so you can depend on it in retirement. As interest rates have risen in recent years, bonds have become an even more attractive option. They can deliver dependable income with significantly less risk, which can be ideal for retirees. There are various types of bonds that you can add to your retirement asset allocation, such as municipal bonds, government bonds, corporate bonds, and Treasury Inflation-Protected Securities (TIPS). Municipal bonds are helpful for tax advantages, while the government can offer more security as they come with a government-backed guarantee. Corporate bonds generally offer higher returns than others but come with a slightly elevated risk profile. TIPS can be helpful in tackling inflation. Depending on your age, you can select a mix that aligns with your financial goals and risk tolerance.
How you invest in bonds is also very important. Even though bonds offer stability, you must know how to manage your bond portfolio to ensure you have a continued stream of income without any interruptions. Bond laddering can be an effective strategy for retirees. A bond ladder refers to purchasing bonds that mature at staggered intervals, such as monthly, quarterly, or annually. When you invest in bonds with varying maturity dates, you protect your funds from changes in interest rates. For example, if interest rates increase, bonds that mature sooner can be reinvested at higher rates. Meanwhile, bonds with a longer term will maintain stability by locking in their returns, even if rates decrease later. Carefully selecting bonds with differing maturity dates and adding them to your portfolio will allow you to structure your monthly income with coupon payments. Say you plan to invest $120,000 in a bond ladder. You might divide this amount into 12 equal rungs of $10,000 each and invest in bonds that mature at intervals over the next 12 years. When one bond matures, you can reinvest the principal into another bond, potentially at higher interest rates. This can ensure a continuous income stream. It also offers diversification as the bond ladder spreads your investment across different time horizons and reduces the risk of reinvesting all your funds in a low-interest-rate environment. However, to enhance your bond ladder diversification, you should consider incorporating a mix of bond types based on your financial goals, such as municipal bonds, TIPS, corporate bonds, etc.
While bond laddering offers numerous benefits, there are a few factors to keep in mind. Bonds can have minimum purchase values, typically $1,000 or $5,000 per bond. So, you would need to make a substantial initial investment to ensure that your bond portfolio is diversified. Moreover, you also need to hold on to all your bond investments until they mature. This way, you can fully benefit from them and earn a predictable income. If you sell bonds prematurely, you may lose income and also incur additional transaction fees.
2. Include equity options like growth and dividend-paying stocks
Equity should definitely have a place in the asset allocation strategy for retirees. It offers the potential for growth, which is crucial in retirement. Playing it too safe with overly conservative investments like bonds may hinder your financial growth, and when inflation comes into play, it can lead to problems. Growth stocks, in particular, can be a solid choice for retirees. You can consider including them in your asset allocation about five years from retirement and, ideally, keep them for roughly ten years into your retirement. These stocks are associated with companies that reinvest their profits back into the business, often to fund expansion. As a result, growth stocks rarely pay dividends. Growth stocks are best suited for those young retirees, as they tend to be volatile and require a long-term investment approach to weather market fluctuations. Ideally, you should commit to holding these stocks for some years to allow their growth potential to materialize fully. Growth stocks come with a high level of risk and are more sensitive to market downturns. Having said that, these stocks have historically been some of the best performers over the long term.
Depending on your risk tolerance and investment timeline, you can add small-cap, mid-cap, and large-cap growth stocks to your portfolio. However, when selecting growth stocks, you must carefully analyze the company. Growth stocks offer a higher earnings potential, but they also have more volatility. So, it is essential to research the companies thoroughly before investing.
Dividend-paying stocks are the second option that you can consider in the equity segment. In contrast to growth stocks, dividend-paying stocks offer a more stable source of income, which can be especially beneficial for retirees. These stocks are typically from well-established companies that pay out a portion of their profits as dividends. For retirees, regular dividend payouts can provide a predictable and reliable income stream and help them cover their essentials easily. Dividend-paying stocks are often considered lower risk than growth stocks because they tend to be from stable and experienced businesses. However, not all dividend stocks are suitable for your portfolio, and there is no guarantee of returns. You should look for companies that consistently pay dividends and have a history of increasing them over time. You can shortlist companies that have raised their dividends annually for the past three to five years. These can provide you with financial stability and the potential for a steady income stream in retirement.
Consider keeping some equity exposure to create a well-rounded portfolio in retirement. At the same time, you must focus on balancing growth and stability to ensure that your money is not exposed to too much volatility. You need to change your portfolio asset allocation by age. Early in your retirement planning, you may focus more on growth stocks to capitalize on their potential for higher returns. As you grow older, you can shift from growth stocks to dividend-paying stocks to ensure a stable income stream while still maintaining some growth potential.
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3. Rely on 401(k)s and Individual Retirement Accounts (IRAs)
A 401(k) is an employer-sponsored retirement plan that allows you to invest your pre-tax salary. It offers tax-deferred growth on your investments, and you finally pay tax when you withdraw your funds in retirement. If you have consistently saved in a 401(k) throughout your career, especially with the added benefit of employer-matching contributions, you may now have a substantial balance to rely on. However, you must know how to manage your 401(k) in retirement to ensure your asset allocation also focuses on your tax dues and not just your gains. Once you turn 59½, you can start withdrawing funds from your 401(k) without any penalties. However, the Required Minimum Distributions (RMDs) only start at age 73 as of 2024. So, if you turned 73 in 2024, you have until April 1, 2025, to take your first RMD. RMDs are calculated based on your 401(k)-account balance and life expectancy. Traditional 401(k) withdrawals are treated as ordinary income and taxed according to your tax bracket. So, you will pay tax depending on your 401(k) balance and your overall retirement income.
You can consider incorporating a Roth IRA into your retirement portfolio to counterbalance the tax burden associated with a traditional 401(k). Since taxes are paid upfront during your working years, Roth IRA withdrawals are not subject to income tax in retirement, and you can make completely tax-free withdrawals in your golden years. This can help to reduce your overall tax liability when paired with taxable 401(k) distributions. If you already have a 401(k) or a Traditional IRA, you can consider converting some or all of it into a Roth IRA. While the conversion amount is taxed in the year of conversion, the withdrawals that you make after the conversion are tax-free as long as you are over 59 ½.
Tax diversification is the key to having the best asset allocation in retirement. So, you must aim to diversify your retirement accounts across tax-deferred 401(k)s and tax-free Roth IRAs. This opens up more doors for you in terms of financial flexibility. You can draw from taxable accounts like the 401(k) and tax-free accounts like the Roth IRA simultaneously and lower your overall tax dues while still enjoying the income level you desire. You must also compare the benefits of traditional and Roth retirement accounts with other assets in your portfolio to diversify and optimize your retirement income.
4. Do not forget Social Security benefits
Social Security benefits are another stable stream of funds in retirement. To qualify for Social Security, you must meet specific criteria. First, you need to be at least 62 years old to start receiving benefits, though delaying your claim can increase your monthly payouts. Second, you must have earned 40 Social Security credits, which typically equates to ten years of work with Social Security taxes. If you have not met this requirement, you may still be eligible for spousal benefits based on your current or former spouse’s work history.
Social Security benefits are inflation-adjusted. Moreover, with provisions like survivor benefits, you can depend on them in your retirement. While these benefits may not be sufficient on their own, combining them with other assets can add immense value to your portfolio. Social Security serves as a near-riskless asset because it is backed by the government. It also offers payments for life. These features help reduce the amount of income you need to generate from other investments. For instance, if your annual retirement expenses total $100,000 and Social Security provides $30,000, your financial assets only need to cover $70,000. This guaranteed income allows you to allocate other funds more strategically within your portfolio. Social Security’s steady income can act as a buffer during downturns and potentially reduce the need to sell investments at a loss. Social Security also helps stabilize your bond portfolio. While bonds provide stability, they may struggle to keep up with inflation. Social Security’s inflation-adjusted benefits help mitigate this risk and offer a more diversified approach to asset allocation.
However, you must plan your withdrawals to maximize the value of Social Security. Delaying your claim beyond the minimum eligibility age of 62 can increase your monthly benefits by a whopping 8% per annum for each year you delay until age 70. In the case of retired couples where both spouses have Social Security, the higher-earning spouse can delay and maximize their benefits while the other can start collecting their benefits earlier. Additionally, you must also evaluate the tax implications of Social Security on your retirement income. Up to 85% of your benefits could be taxable depending on your overall income. You must consider planning your withdrawals, not just from Social Security but also other assets like the 401(k), bonds, stocks, etc.
To conclude
While there is no fixed template for the perfect retirement asset allocation, focusing on a mix of stability and growth can help you strike the right balance. Your ideal allocation depends on several factors, including your risk tolerance, income needs, life expectancy, and financial responsibilities. Taxes play a significant role, too. Working through these complexities can be tricky, which is why consulting a financial advisor is often a smart move. Use the free advisor match tool to get matched with seasoned financial advisors who can help maintain an ideal asset allocation in retirement based on your financial needs and goals. Answer some simple questions about your financial needs and get matched with 2 to 3 advisors who can best fulfill your financial requirements.
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