Asset Allocation for Retirees
Investors often search for advice on their optimal portfolio asset allocation—a portfolio’s mix of stocks, bonds and other securities—when they are in retirement. However, a retiree’s optimal asset allocation may vary because it depends on their unique situation and investing goals. Much of the investing advice out there encourages retirees to follow potentially misguided strategies, such as investing primarily in low-yielding or income-generating securities. At Fisher Investments, we believe these strategies can increase the risk of possibly not achieving long-term financial goals.
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One common piece of advice advisers may give retirees is to shift retirement portfolios’ asset allocations away from equities over time—typically to fixed-income or other lower volatility investments. But this kind of “age-based” approach to asset allocation isn’t always the best option. We believe it perpetuates common misconceptions about proper asset allocation for retirees, which can include:
- Failing to understand inflation’s impact on a portfolio’s purchasing power over the long term.
- Assuming retirees can only achieve their income needs by investing in income-generating securities.
- Viewing fixed-income investments (such as bonds) as a safer alternative to those with more short-term volatility (like stocks).
These misconceptions can increase the risk you don’t achieve your investment goals and potentially require you to alter your lifestyle as a result. We think being aware of how to avoid common pitfalls while investing as a retiree can increase your chances of success.
Costs to Consider
What costs will you incur when you are retired? Even the most thoughtful investor may overlook certain costs that will affect their retirement strategy and overall income needs.
For example, retirement is a time when many retirees start to travel extensively, pick up a hobby to occupy their time or have an active social life. Investors should consider these potential costs when retirement planning, as well as the costs they may incur to cover any education-related expenses of children or grandchildren.
Medical expenses generally grow with age as reliance on medical equipment, devices and prescriptions increase. Retirees should also factor in potential costs of in-home care, hospital visits and assisted living.
Inflation’s Impact is Insidious
Most people understand inflation will require them to pay higher prices for goods and services over time. But few factor higher prices into their income planning. Retirement income must at least keep pace with inflation. Investors who focus too much of their portfolio’s asset allocation in fixed-income or lower-yielding products risk the potential of losing purchasing power over time, forcing them to dip into their principal.
Since 1925, inflation has averaged about 3% a year.1 If that average inflation rate continues into the future, a person who currently requires $50,000 per year in income to fund their annual living expenses would need approximately $90,000 per year in 20 years, and about $120,000 in 30 years just to maintain the same purchasing power. It’s important to have an asset allocation that provides enough growth to overcome the insidious impact of inflation.
Investment Income Stability
Many tout fixed-income as a way to secure a steady stream of investment income during retirement. But fixed income is far from the only way to receive cash flow from your portfolio. Fixed income can be useful for some retirees in certain situations, but you should also be aware of the risks.
Fixed income instruments, like bonds, normally pay a fixed rate or “coupon rate” on an ongoing basis, but they only pay over a specified term. If new bonds aren’t available with the same rate as the maturing bonds, then a portfolio’s income may fall even though it maintains the same asset class allocation. We call this reinvestment risk—the potential that your future bond payments may have to be reinvested at a rate lower than your original investment.
There are other risks with fixed income as well, including default risk—the risk that the issuer could default and you might not get your entire principal back. Interest rate risk is the risk that interest rate changes reduce the value of your bonds.
A Longer Time Horizon
When retirees allocate their retirement portfolios too heavily towards fixed-income and other lower-yielding investments, they may run the risk of not meeting their long-term investment goals. This situation applies especially to those retirees who require portfolio growth in retirement.
All these risk factors become more prominent the longer the investment time horizon. Unfortunately, investors often miscalculate how long their retirement investments and income may need to last. Specifically, investors tend to underestimate how long they will live. With advances in medicine and medical care, people are living longer on average. This means an investor who retires at age 60 could reasonably expect to live another 25 years or more, and their asset allocation for retirement should reflect that possibility.
Depending on their individual financial situations, retirees requiring portfolio growth should consider keeping a sufficient portion of their asset allocation for retirement in equities. Over 30-year time periods, a diversified equity portfolio shows higher returns and a lower standard deviation—meaning lower volatility—than a fixed-income portfolio.
And though many advocate for bonds’ steady coupon payments, investors with a diversified equity portfolio can often create similar cash flow by strategically selling off small portions of their portfolios—a practice we call “homegrown dividends.”
Fisher Investments Can Help
Fisher Investments can help retirees in many aspects of managing their retirement investments, from early stage retirement planning to ongoing portfolio management. Our team can help you:
- Define your long-term retirement goals
- Choose an optimal asset allocation based on those goals
- Manage your retirement assets leading up to and during retirement
At Fisher Investments, we can help you keep your investments aligned with your goals while you enjoy your retirement. This includes helping you remain disciplined through difficult markets and altering your investment strategies if your goals or circumstances change. We do this by providing you with world-class client service and a dedicated investment professional. Contact Fisher Investments today to request a complimentary consultation and portfolio evaluation or read more in one of our guides.
1 Source: FactSet as of 08/32/2022. Based on US BLS Consumer Price Index from 1926-2021 showing average 2.9%