As you approach retirement, you may be tempted to shift most of your savings to more-conservative assets. That temptation may be particularly strong in today’s volatile market.
But this strategy could increase the risk that you’ll outlive your money. If you retire in your early sixties, you may need your savings to last more than 30 years. While interest rates on bank savings accounts and money market funds have moved higher in recent months, their yields still lag the rate of inflation. The only way to stay ahead of the curve is to maintain a diversified portfolio of stocks, bonds and cash well into your retirement years.
The amount of savings you invest in stocks will depend on several factors, including the amount you’ve saved and your tolerance for risk.
Other assets matter too: If you have a traditional pension that covers your essential expenses, for example, you can probably afford to invest more in stocks because you’ll be able to ride out market downturns. Otherwise, you could be forced to take withdrawals from your nest egg during market downturns, which could create a permanent hole in your portfolio.
You can avoid this scenario by dividing savings among three “buckets.” The first is designed to cover living expenses for the next one to three years, after you tap a pension or an annuity (if you have one) and Social Security. The second bucket contains money you’ll need over the next 10 years and can be invested in short—and intermediate-term bond funds. The third bucket is filled with riskier assets that offer the greatest potential for growth—primarily stocks and stock funds—that you won’t need until much later.
When it comes to your different retirement accounts—tax-deferred, tax-free, taxable brokerage—where you invest matters, too, says David McClellan, a partner with Forum Financial Management in Austin, Texas. Ideally, you’ll invest assets with the highest potential for growth, such as small-value or emerging-markets stock funds, in your Roth accounts, McClellan says. That way, you’ll benefit the most from tax-free growth.
Investments with lower long-term returns—primarily fixed-income investments—belong in your tax-deferred accounts because they’ll grow more slowly, which reduces the amount of assets that will be taxed at your ordinary income rate when you withdraw them in retirement.
Stocks and stock funds that generate most of their returns from capital appreciation belong in your taxable account, because returns will be taxed at the typically lower capital gains rate.
This strategy may be difficult to pull off if you have most of your savings in a 401(k) plan, particularly if you’re investing some funds in a Roth 401(k). Most employers don’t allow you to designate different portfolios for your regular 401(k) and a Roth, McClellan says. But as you change jobs and roll over 401(k) plans to IRAs—and if you also convert some of those funds to a Roth—you may have more opportunities to fine-tune asset location.
(Sandra Block is a senior editor at Kiplinger’s Personal Finance magazine. For more on this and similar money topics, visit Kiplinger.com.)
