Are you over 50? If so, how much risk do you have in your portfolio?
This is, of course, a key question for anyone nearing (or in) retirement.
But while it’s important, answering that question isn’t easy.
Some financial professionals may prescribe an acceptable risk-ratio by applying a rule of thumb.
But when it comes to saving and investing for your retirement, there is no one-size-fits-all equation.
Here’s why.
How much of your portfolio should you have in stocks? One rule states that you should subtract your age from 100 to get an approximate percentage. (For instance, if you’re 60, you would have 40% of your portfolio in stocks.)
But that’s worrisomely vague, isn’t it?
That’s because an ideal asset allocation involves deeply personal and complex assessments, and is very difficult to achieve using any single formula.
The “right” portfolio allocation is the one that works for you on numerous levels. Here are three considerations:
1) Your Time Horizon
By “time horizon” I mean, when are you going to need your money?
It’s as important as any aspect of the investment process.
That’s because understanding precisely when you’ll need your money helps determine the types of investments you’ll select, and the amount of risk you might be willing to take.
Remember:
- You won’t need all your savings on the day you retire
- Poorly-timed distributions from your investments can needlessly cost you thousands (or even tens of thousands) of dollars in taxes
- Ideally, you should strive to live off the income generated by your investments and not the principal
- That’s because spending your principal is a double whammy:
- First, with each disbursement or withdrawal, you’re spending your savings
- Second, you’re reducing your future income by using the money you’ve invested
2) Your Risk Tolerance
All investments contain risk. The question is, how much risk are you willing to endure?
First, if when I mention “risk” the first thing that jumps into your mind is the current level of the stock market, and that makes you feel anxious, one way or the other, that’s a red flag.
That’s because, generally, your risk exposure should not change because the bears or bulls are running.
You are not a day trader, and your portfolio is not to be treated like gaming chips in a casino.
Your risk tolerance should change as you do (based on age, nearness to retirement, your dependents, etc.), and not as the market fluctuates.
And if you aren’t working with someone who helps you nail down your risk tolerance profile, you should be concerned.
You may be putting yourself, and your future, at peril.
Additionally, the urge to leap in and out of the market (based on its performance) may be natural and human, but it’s also a mistake. This is Behavioral Finance #101, and it’s precisely what a good fiduciary advisor should keep you from doing.
Each time you meet with an advisor, you should discuss your risk tolerance, and decide if you are still entirely comfortable with the allocation of your portfolio.
And if not? Make the necessary adjustments to bring your allocation back in line with your comfort level.
3) Your Diversification
First, with some exceptions, generally, the older you get the more conservative your investments should become.
Second, for those of you who are already retired, depending on your income, and other assets, you may be better off taking some distributions from your retirement accounts before you reach age 70½.
Third, for those of you who are still employed, you should think (and invest) outside the retirement account [401(k)/IRA)] box.
I regularly meet people who’ve proudly maxed out their contributions to their 401(k)s for years and years. That’s good.
But if you have a substantial balance (and all your retirement savings) in a 401(k), not only are all your eggs in one basket—which is risky and illiquid—if you’re already in your late 60s, and have a large retirement account balance, you could end up unnecessarily paying the taxman a lot of money when those required minimum distributions (RMDs) hit you at age 70½.
Simply, if you’ve been faithfully contributing to your 401(k), your mandatory withdrawals could be so large that you’ll find yourself bumped up into a higher tax bracket.
Almost any way you look at it, you benefit when you diversify.
Conclusion
Remember, the proper amount of risk in a portfolio considers your:
- Tolerances
- Time horizon
- Diversification
- The number, age and future needs of your dependents
- Lifespan expectations
- And other assets …
Just to name a few.
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