The common approach to retirement planning is to shift your assets away from equities as you approach retirement. The idea is that most of your money should be in “safer” assets like bonds and cash during retirement.
Inflation and your retirement portfolio. One of the biggest challenges you are likely to face in retirement is inflation. If you use the 4 percent rule to withdraw from your portfolio, and if the market has a few down years, there’s a good chance that the “safe” assets in your nest egg won’t provide returns that keep pace with inflation.
This means that, not only could you be dipping into your original capital, but you might also be seeing real losses as you lose purchasing power to inflation. Combine this with the fact that it’s possible that you will spend 30 or 40 years in retirement, and you could easily outlive your money.
In order to make sure that inflation, combined with low returns on your portfolio investments, doesn’t lead to a cash crunch later in your retirement, you need to make sure that you aren’t relying too heavily on the “safer” assets.
Adding growth to your retirement portfolio. You’re probably a little nervous about the idea of adding risky assets to your portfolio during retirement. I’m not saying that you have to replace everything in your portfolio with growth investments, but you do need to make sure that these assets are included in your retirement portfolio.
Growth assets can help you continue building wealth even during retirement. Even if all you do is put an appropriate proportion of your portfolio in index funds, it’s still better than having almost everything in low-yield bonds or cash products.
One of the suggestions that many retirement experts like right now is the “bucket” approach. You can divide your portfolio into three parts. The first part is highly liquid and low risk. This is money that you need to access within the next five years. You won’t be earning much of a return on this money, but it’s available for your use.
The next part of your portfolio is for money you need in five to 10 years. These assets offer some growth, but aren’t very risky. Dividend stocks and relatively stodgy index funds can be included, as well as bonds that might be a little riskier. You end up with the potential for modest growth, but you aren’t overly exposed to risk.
Finally, you put a portion of your portfolio in assets meant for growth. That way, you have the potential to build wealth. You can move money into different “buckets” as your retirement progresses.
You don’t have to divide your portfolio into three equal parts to make this work. The important thing is to stop thinking in terms of “safety” for your retirement assets, and do your best to add a little more growth. That way, your money has a better chance of outlasting you.