You’ve put money aside for retirement year after year, sometimes the max, sometimes less when you had expenses to pay. You’ve invested it well, so now you have a good enough nest egg to carry you through the next phase of your life — retirement.
What now?
There are plenty of vehicles aimed specifically at investing for retirement, especially target-date funds, where fund managers reduce your stockholdings as your chosen retirement date draws near.
But once you get there, the only certainty is that you’ll have to draw down the assets you’ve accumulated in your traditional IRAs and 401(k)s through required minimum distributions (RMDs) starting the year after you turn 70½.
Before you retire, you should see a reputable financial planner to sort it all out, but many investment advisers are stuck in old thinking and conventional wisdom about how to invest it.
So, I’m going to suggest how you can do it yourself. The goal is to set up a stream of income that will last the rest of your life, the “personal pension” we’ve been writing about in Retirement Weekly over the last few months.
But first, let’s talk more broadly about how to approach investing in retirement
Retirees face four kinds of risk.
First is the risk that inflation will erode their nest eggs over time.
Second is that rising interest rates will cut into stock returns and reduce the value of their bondholdings. (The other side of the interest rate coin is deflationary negative interest rates, which plague Europe and Japan, driving yields down for savers all around the world.)
The third risk is that not having enough growth in your portfolio will cause you to run out of money.
And finally there’s what academics call “sequence of returns” risk — that you’ll retire just when a bear market hits, depleting the nest egg from which you calculate your withdrawals.
The risks of inflation and higher interest rates seem remote now, but the risk of outliving your money is real and 10 years into a bull market, with the Dow Jones Industrial Average DJIA, -0.31% and S&P 500 index SPX, -0.23% at or near all-time highs, hundreds of thousands of baby boomers may well retire in the teeth of the next bear.
You counteract longevity risk by owning stock. You combat “sequence of returns” risk by owning the right amount of stock and holding plenty of cash.
What is the magic number? According to the Employee Benefit Research Institute (EBRI), Americans held roughly 50% (nearly 60%, including balanced funds) of their IRA assets in equities as of 2016, the most recent data I could find. Stock allocations dropped sharply when people turned 60, EBRI’s data indicates, remaining at roughly 48% to 55% for the rest of their lives.
Similarly, Fidelity reported that the percentage of its account holders who had invested their 401(k)s entirely in stock had halved over the past decade, to only 7% by 2019’s first quarter. “Employee asset allocation has improved greatly over the last 10 years,” Fidelity observed, attributing that to the spread of target funds which protect many investors from their worst instincts. (Some 69% of millennials with Fidelity accounts are 100% invested in target funds. Good for them!)
But, the firm warned, “baby boomers are the most likely generation to be too aggressively invested — potentially putting them at risk so close to retirement.”
So, what should you do? Once you retire I’d consider keeping no more than 50% or 60% of your money invested in stocks. To insure you won’t have to dump plunging shares into a bear market, I’d suggest keeping at least three years’ worth of RMDs in cash. Since you can withdraw RMDs from any account, this will help you wait out the bear.
If you have a Roth IRA you plan not to touch for a few years, that’s where you can be more aggressive in stocks.
Let’s assume Julie Jones has $400,000 in a traditional IRA and another $100,000 in a Roth. In the traditional IRA she keeps $80,000 in cash, while in her Roth she has no cash and puts $80,000 in stock and $20,000 in bonds. The table below shows how it breaks down — 80% stock in her Roth, 50% stock in her traditional IRA, 56% in equities overall, but with a big cash cushion to absorb the risk.
How Julie Jones invests for retirement
| Total assets | Stocks | % in stocks | Bonds | % in bonds | Cash | % in cash | |
| IRA | $400,000 | $200,000 | 50% | $120,000 | 30% | $80,000 | 20% |
| Roth IRA | $100,000 | $80,000 | 80% | $20,000 | 20% | 0% | |
| Total | $500,000 | $280,000 | 56% | $140,000 | 28% | $80,000 | 16% |
(This is a hypothetical exercise. All data provided by MarketWatch.)
If she didn’t have a Roth, she might keep 60% ($240,000) of her traditional IRA in stocks, 25% ($80,000) in bonds, and $80,000 (25%) in cash.
The point is, you need to balance the risk of too little growth with the risk of too much equity exposure at the wrong time. There are many ways to get there, but it’s vital to keep that principle in mind when deciding how to invest your money when you retire.