When it comes to retirement savings, at some point you transition from aggressive investments to a more conservative portfolio. The big question though, is when do you know it's time to make that move, to play it a bit more safe with your nest egg?
It's not all about age
Retirement is such an individual adventure it's hard to make generalizations because everyone's situation is different. But that said, there are some guidelines that can help you make up your mind.
For one thing, realize that conservative or aggressive does not depend on age, says Matthew Tuttle, CEO and Chief Investment Officer for Tuttle Tactical Management. “What is conservative is a moving target,” he says.
Take for example, he says, the fact that for 30 years bonds have been conservative because they didn't go down. “Does that mean they will always be conservative? No. They didn't go down because interest rates went down in a steady drop. Now interest rates are going up, does it make sense for someone near retirement to shift to bonds in a rising interest rate environment? No,” he says.
Conservative is about being in harmony with market trends. Under that definition, you should always be conservative, he argues. “Just like you wouldn't want bonds now, you wouldn't want stocks in 2002 in 2008. So every investor, regardless of age, should be in harmony with market trends.”
Age is but one component to consider when configuring an investor's asset allocation. “It's also important to consider an investor's risk tolerance and their need for income,” points out Ken Mahoney, president of Mahoney Asset Management. “Depending on how much income per year an investor needs will affect how much of their assets are used to provide that stream of income and which assets are going to provide the most consistent, steady stream,” he says.
Just because you have entered, or will soon enter retirement by itself, is not a reason to adjust to the portfolio to a more conservative posture, says Dan Crimmins, co-founder of Crimmins Wealth Management.
Generally, shifting a portfolio occurs gradually over time. “Unless an unforeseen event occurs, I hardly ever recommend a client shifts a portfolio dramatically at any given time. We age gradually, overtime, not in 10 year increments. Portfolios should be treated the same way,” says Derek Holman, managing director of EP Wealth Advisors.
While he doesn't like to use general formulas, as a starting point he classifies investors in three categories – savers, approaching retirement (retiring sometime in the next decade) and retired.
He says savers should think about keeping a set amount in fixed income as a safety net. For some guidance, he suggests that it be a figure that would cover a set net of months of living expenses, anywhere from 6 months to five years, depending, he says on job security, income variability and other factors.
Those approaching retirement should think about how much they will be drawing down on the portfolio during retirement, in addition to considering a safety net in case work income terminates earlier than expected. This ratio between the withdrawal rate and the safety net changes as they get closer to retirement.
Holman says that retirees should mainly focus on their withdrawal rate. An oversimplified formula, he says, would be to take the annual withdrawal rate and multiply it by 10 and place this amount in bonds.
Don't pull back too soon
The big risk facing retirees is longevity risk – the risk of outliving one's assets. “Medical advancements and the fact that people are living longer, some up to 30 years past retirement is significantly increasing the amount of money that people need to save,” says Bob Stammers, director of investor education at the CFA Institute, a global nonprofit organization of investment professionals.
You don't want to outlive your money. “The danger of pulling back too early is opportunity cost. Being overly defensive can have an impact on the overall average return of the investment and potentially cause a shortfall in meeting your objectives,” cautions Brad Bofford, managing partner of Financial Principles.
Larry Springer, a certified financial planner with West Railroad Tax Services believes the time to transfer to more conservative investments is when the need to use the money is more near-term, rather than money to be used over a long period of time.
Have a plan
“You should only shift your approach to investing if your financial goals themselves have shifted. There is no one-size-fits-all formula to determine when or how to modify your investment strategy – but your investment strategy should always reflect your current situation and fit your long-term objectives, needs and wishes,” says Elle Kaplan, CEO and founding partner of Lexion Capital Management.
Create an Investment Policy Statement to stay on track, says Kaplan. This document outlines your objectives, specifies your overall investment strategy and articulates your financial vision. Revisit it annually and after major life events and transitions. No doubt it will help make it clear when it's time to start shifting your investments to safer waters or whether you should stay right where you are.