Running a marathon without training is a bad idea. Same goes for betting your last $100 on lucky 17 at the roulette table, or trying to save for a comfortable retirement when you know little about investing. The odds of coming out ahead all around are pretty low.

In a recent survey, Schroders Investment Management questioned 1,004 men and women aged 45 to over 70 about retirement planning. More of than half of these respondents -- 54% -- weren't clear on how to invest their money in retirement. This lack of expertise around investing appeared in other survey metrics as well. Some 55% of respondents admitted they didn't know how their assets were allocated. And 42% said they were concerned or very concerned about outliving their assets.

Gamblers at the roulette wheel

Image source: Getty Images.

If you're not sure how your money is working for you, you're also not clear on how much you need to retire comfortably. And once you do retire, you won't be confident about how long your money will last. Let's tackle those uncertainties now with a review of the investment basics you need to know.

Principal versus earnings

As you near retirement, it's helpful to distinguish between principal and earnings in your portfolio. Principal is the base amount of funds you invest; think of it as your portfolio's balance as of Jan. 1 each year. Over the next month, quarter, and year, your invested principal produces earnings in the form of dividends, interest, and capital gains. Here's the point: The trick to making your money last for decades is to keep the principal fairly intact and live off the earnings.

The 4% rule vs. 7% return

Financial planners use 7% as a guideline for long-term investment return, because that's how the market has performed historically. While it's reasonable to plan for 7% returns in your portfolio, the actual performance in any given year will be higher or lower than that. In 2019, for example, the S&P 500 Index grew almost 29%. But in 2008, it declined 38.5%.

If you were guaranteed a 7% return each year, you could withdraw that 7% in earnings without touching your principal. But the market doesn't have guarantees, and so you have to manage proactively for volatility.

This is where the 4% rule comes into play. The rule advises that you can safely take a 4% to 4.5% withdrawal from your invested portfolio in your first year of retirement. In subsequent years, you can adjust that 4% or 4.5% to keep pace with inflation. This rate of withdrawal is considered "safe" because it's low enough to allow for short-term market downturns that affect your principal balance.

In reality, most people who follow the 4% rule may die with more money than they had on the day they retired. This is a trade-off you make to account for the worst-case scenario of market conditions. 

You might wonder if not investing your cash would be a smarter way to protect your principal. The answer is no. Let's say you have $1 million on hand. The 4% rule says you can withdraw $45,000 annually, adjusted for inflation, and your money will last 30 years. Here's what happens if you don't invest: 

  • If you stuff the $1 million under your mattress, you can spend $45,000 annually for about 22 years. At that point, you run out of cash.
  • You could put the $1 million in a cash savings account earning 2%. Your first-year earnings will be $20,000, but your $45,000 withdrawal will reduce your principal. In the second year, you'd start with a lower balance of $975,000 -- which produces lower earnings. You won't be able to increase your distributions to match inflation and you'll definitely run out of money in 29 years and three months.

Asset allocation

Asset allocation is the composition of your portfolio across different asset types, such as cash, stocks, and bonds. These asset types behave differently:

  • Cash doesn't lose value, but it does lose buying power, by way of inflation.
  • Stocks and stock funds have high growth potential but can also lose value quickly when market conditions change.
  • Bonds and bond funds generate predictable earnings but have lower growth potential than stocks and stock funds.

You can use those differences to manage your risk while optimizing your earnings. While you might be tempted to double-down on stocks for their growth potential, that's only advisable when retirement is still decades away -- when you have time to ride out any market downturns.

If you are in retirement or near retirement, you're far better off holding 40% to 50% of your money in bonds or bond funds. The 4% rule confirms this, as it originally assumed an allocation of 50% invested in the S&P 500 Index and 50% invested in intermediate-term U.S. Treasury bonds. You could mimic that portfolio with an S&P 500 index fund like the SPDR S&P 500 ETF (NYSEMKT:SPY) and an intermediate-term bond fund like the Vanguard Interm-Term Treasury Fund (NASDAQMUTFUND:VFITX).

Invest and withdraw conservatively

You can invest aggressively -- and even play a little roulette -- when you're young. But as you near retirement age, it's time to limit your exposure to big principal losses. You do that by adjusting your asset allocation and managing your withdrawals so they don't cut into your earnings power going forward.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.