How Much of Your Portfolio Should Be in Stocks When You Enter Retirement?

March 9, 2009 was a bad day to retire. On that day, the Dow Jones Industrial Average hit its bottom of 6,547, a low not seen since 1997. If you followed mass-market retirement investing advice, you may have entered retirement with a portfolio 100% invested in a stock market index, like the S&P 500, whose pattern is similar to the Dow.

If you began formally planning a year in advance on March 9, 2008 with a portfolio worth $1,000,000, by the time you retired one year later, that portfolio may have only been worth $600,000. This market drop has left investors feeling betrayed by the long-term promises of a diversified portfolio stocks, usually touting an eight to twelve percent return over long periods of time, depending on whom you ask.

This is no consolation to new retirees who lost 40% or more of their portfolio and have had to change their plans. Unless you cash out your entire investment portfolio on the day you retire, the market drop won’t have a permanent effect on your finances. If you are healthy, you can expect to live several decades in retirement. Your portfolio must be aggressive enough, even in retirement, to last as long as you need it. Stocks might still be an important part of your portfolio in order to achieve the growth necessary for your income from investments to last at least as long as you continue live.

The recent downturn has forced people re-evaluate the level of risk they are willing to accept in their portfolios. When the market experiences a multi-year rally, investors are more likely to say they are willing to accept risk if it will increase the chances of long-term growth, while economic recessions frighten investors away from the riskier choices. While these are human instincts, the more you can separate your emotions from your finances, the better you will be off in the long run.

This is a difficult task thanks to the exabytes of information we can access about our own money with the click of a button. We receive quarterly statements from our investment accounts in the mail explaining in plain text how much money we have lost on paper, and these statements do not apologize nor do they include just one frowning emoticon to make us feel better.

While stocks are the best bet for long-term growth, a balanced portfolio should include some bonds to cover retirement funds you may need within ten years. On the date you retire, you should know how much money you’ll need to draw from your investments each year. Your bonds should cover that amount, leaving room for some growth. But that needs to be balanced by your long-term needs in retirement. Having too much invested in bonds runs the risk that your investments will not last throughout the remainder of your life. If your nest egg is small, keeping ten years’ worth of income in bonds may not leave enough of your portfolio left for stocks, if any.

This difficulty is one of the primary reasons people often choose annuities for retirement. You can take a part of your retirement nest egg and buy an insurance product that “promises” a certain absolute return for a set period of time or the remainder of your life. Buying an annuity when you’ve all ready lost 40% of your account value can result in a smaller benefit than you were planning to live on, and that could be a problem.

There is no easy solution to this problem. Even if you don’t retire on the day the stock market hits its lowest point, chances are good the stock market will be significantly down during some point during the next few decades. Here is what I plan on doing:

• Approaching retirement with an investment allocation among stocks and bonds that matches by true level of risk tolerance. It’s best to measure your risk tolerance during a period in which you are experiencing neither high or low returns on your investments to keep emotions and short-term memory out of the equation.
• Rebalancing my portfolio periodically to ensure I’m not more exposed to any investment type. As stocks experience a boom, it’s natural to keep money in stocks to ride the wave. Avoid a crash by keeping an eye on the percentages and move money around when the portfolio is unbalanced.
• Adjusting my asset allocation using the lowest risk investments that will provide the needed returns. Suze Orman, with a portfolio value of $25 million, keeps $24 million invested in bonds. These investments results likely approach $1 million each year. She also investments another $1 million in stocks, an amount she can afford to lose. If annual needs are provided for by an investment offering a lower but more stable return, stick with the lower-risk investments rather than accepting unneeded risks.

What will your portfolio look like when you entire retirement?

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