By: Frank Armstrong, CFP, AIFA
An aid to manage risk in retirement accounts
Here’s an easy way to estimate how much risk you should take at each stage of your career.
It’s critical that you take the right amount of risk at each stage of your career to position yourself for a safe secure retirement. If you don’t take enough risk you may never accumulate enough for retirement. But if you take too much risk your probability of a successful retirement may actually decrease. And the amount of risk you should take will vary over your career as your time horizon changes. But how can you know how much risk should you be taking?
The most important factor to consider is your time until retirement. Early in your career, time is on your side, it makes sense to have a high exposure to equities to capture their higher return potential.
As you approach retirement later in your career you will need to balance your need for liquidity and safety by reducing your equity exposure somewhat. However, you never outgrow your need for equities. Even at advanced ages it makes sense to hold a healthy position in the world’s stock markets.
As a guideline to assist investors we’ve developed the glide slope approach that smoothly transitions the investor as his career progresses. Because not all investors have the same risk tolerance or financial situation the glide slope provides for a range of reasonableness. However, we believe that the suggested portfolios are prudent, time tested, and offer the highest probability of success over your career.
The investor’s first decision to control risk and provide liquidity in his portfolio is the percentage of stocks versus bonds or fixed income. Next, both the equity (stock) and fixed income (bond) portions of the portfolio should be as close to optimum as possible in an uncertain world. We think that means a globally diversified equity portfolio and a high quality short term bond portfolio. The makeup of the two sections, stocks and bonds, doesn’t change; but, the percent that each section represents in the portfolio varies.
Early in your career, you may very well wish to have a 100% equity exposure. This value of this position will of course vary as the market goes through its cycles, but historically offers the best possibility for meaningful growth of real value.
We believe that an investor should be positioned in his retirement portfolio well in advance of the actual retirement date. After all, you don’t want your decision to retire to be based on what the market did yesterday.
The glide slope illustrated will help you to manage the transition gracefully from a high exposure to equities to a more balanced account as you approach retirement.
We’ve designed the glide slope assuming that the investor plans a reasonable 4% withdrawal rate during retirement, wishes to have 10 years of liquid reserves at retirement, and wants to be positioned in his retirement portfolio five years prior to his actual retirement. So, the retirement portfolio would consist of 40% high quality fixed income, and 60% equities. Over time a mix like this has a high probability of supplying the steady income retirees need, providing a modest growth sufficient to outpace inflation, and never running out of money.
Using the glide slope is easy. Just enter the chart with your time to go to retirement, and read the suggested stock/bond split for your portfolio. Then adjust your retirement accounts accordingly. Check back and adjust every few years and you will maintain the right amount of risk for your stage in your career.