Some investors take an aggressive approach to their retirement portfolios, even as they near their planned retirement. Perhaps their accounts have performed well in recent years, and because they have not quite reached retirement savings goals, they hope a higher-risk allocation will help them reach those goals. Even with a clear understanding of the risks, the potential for higher returns can be tempting — especially when time is running short.
But then the market turns. Instead of the rebound these investors hope for, the decline continues. What was once a healthy portfolio full of gains starts to shrink. With retirement only months away, their losses become real and significant. In many cases, portfolios drop tens of thousands of dollars, resulting in a meaningful reduction in monthly retirement income.
This scenario has played out for many retirement investors over the years. And while each situation is unique, the lesson is the same: keeping your asset allocation in check is critical, especially as you approach retirement.
Asset allocation is the process of dividing your portfolio among different categories of investments or asset classes such as stocks, bonds, and cash. Retirement accounts typically provide access to a variety of investments including stocks, bonds, and mutual funds. The purpose of asset allocation is to match your allocation with your financial goals, risk tolerance, and time horizon.
Financial goals are financial objectives that determine how much money you need and when you need it.
Risk tolerance defines the amount of market volatility or risk you can accept. This is usually based on age and financial goals, and it can change throughout your life.
Time horizon is the time remaining until retirement, when you want to start withdrawing your funds.
These factors should be the drivers of your asset allocation, no matter where you are on the path to retirement. The general goal is to help diversify your portfolio, keep you invested, and soften the effects of big market fluctuations.
For people in their 20s or 30s, an aggressive investment strategy more weighted in stocks can make sense. These individuals have time on their side to ride out market dips and volatility. However, this same approach becomes risky as you edge closer to retirement. Why? When your time horizon has shrunk, and you are just a few years — or even months — away from needing to withdraw funds, you may not have enough time to recover from a significant market downturn.
Steps to Consider When Planning
Create a plan. Rather than waiting to the last moment to adjust your investments, start planning your transition 5-10 years before retirement. Let the three factors above influence your asset allocation decisions.
Monitor investments. Over time, your portfolio can experience allocation drift due to fund performance. You may start out with a 60/40 stock to bond ratio, but over time the balance of your funds may be at a 75/25 stock to bond ratio. It is helpful to review your fund balance allocation yearly and, if need be, rebalance your portfolio to bring it back in line with your target allocation.
Avoid chasing returns. It is tempting to stay aggressive when the market is booming, but none of us knows when a downturn is coming or how long it will last. That is why it is crucial to adopt a more balanced approach, with an allocation based on your financial goals, risk tolerance, and time horizon, not current market performance.
One of the most common missteps in retirement investing is setting an asset allocation and never revisiting it. A wiser approach involves regular check-ins to ensure your portfolio remains aligned with your financial goals, risk tolerance, and time horizon. While we can’t control market fluctuations, we can control how we respond…and how we prepare. Don’t wait until the final stretch to make crucial adjustments.
Take time to develop a thoughtful plan and stay committed to it. Your future self (and your peace of mind) will be better for it.
About the Writer: Chris Compton is CFO for Richland Ave Financial. He graduated in 2007 with an M.A. in Bible Exposition from Columbia International University. A 1998 graduate of East Tennessee State University, he has over two decades of administrative and financial experience in varied fields, along with seven years in pastoral ministry.
Disclosure: The information contained in this article is for educational purposes only. Richland Ave Financial does not provide investment advice nor should its educational resources be considered investment advice. For investment advice, please consult a financial advisor who can help you develop a strategy tailored to you.
