Should Your Asset Allocation Change As You Near Retirement?
The answer is: probably. Now, there is no cookie-cutter, or right answer of an asset allocation by age that everyone should have. That said, as you near retirement, your goals may be shifting. Your time horizon is shifting. It’s worth it to check in on your asset allocation to determine if it’s still appropriate for you.
Asset allocation is the percentages of cash, stocks and bonds that you have in your portfolio. We tend to remove cash saved for the emergency fund and short-term goals from this equation. This leaves you with stocks, which historically has a higher return but are more volatile, and bonds, which is more stable, but the returns are lower. This balance of risk and return is different for each person, because it depends on your time horizon and your risk tolerance.
You may have heard the “Rule of Thumb” that says that to come up with your proper asset allocation, subtract 100 by your age for the percentage of equities you should keep in your portfolio.
This means that if you are age 60, 100 – 60 = 40, you would have a 40% allocation of equities in your portfolio.
This rule of thumb indicates that as you grow older, you become more conservative, searching for less risk and more stable returns with a higher percentage in bonds, and less volatility by reducing exposure in equities. When you’re nearing retirement, you don’t have as much time as you did when you were younger to recoup your money after a market crash. And once you no longer have a regular income after you stop working, you’re less likely to risk losing what you’ve accumulated. If this description sounds like you, it makes sense to dial back the equities in your asset allocation.
Like any generalization, it’s a fine starting point, but then you need to make it appropriate for you individually. Think about what goals you need those funds to meet as well as your comfort level with the amount of risk you are taking—being able to “sleep at night” when there is volatility in the market. For my dad, he was fine living off the dividend income of his portfolio so that the principal of the account would pass on to his kids when he dies. In this example, his time horizon of the account is when me and my siblings would use the funds, so he was okay with his higher equity exposure. If leaving a legacy sounds more like you, you may be comfortable with taking additional risk.
You actually don’t even need all of your assets in the same allocation. The three buckets of money concept pegs the investment allocation to your timeline of when you need the funds versus strictly by age. The Three Buckets for Savings and Investments will direct you to how you’ll allocate the accounts in equities and bonds. Some funds will be safe for immediate use within a short time horizon, and more risk can be taken with funds needed for longer time periods. This structure allows you to always have your money working for you at the optimum risk/reward level!
So, should you change your asset allocation as you near your retirement? Probably. Think about your time horizon when you’ll need the funds and change the asset allocate accordingly – just be sure to take the amount of risk appropriate for you and not just based off a rule of thumb, and revisit your decision once or twice a year.