Source: Steven Depolo via Flickr.
A lot of the investment advice you read has to do with planning for retirement -- and for good reason. After all, achieving financial freedom and having the means to live life on your own terms is a big part of the "American dream."
However, what should you do with your money after you retire? Should you keep your money in the same investments, or should you get more conservative? And how much should you withdraw every year?
Don't get too conservative
Having the majority of your investments in stocks or stock funds is completely fine, even during the latter stages of your working life. Many people achieve big portfolios that can see them through retirement by harnessing the awesome power of compounding stock returns.
However, once you retire, some changes may be necessary. In a nutshell, you need to find a compromise between risk and return. You certainly want your portfolio to produce enough income that your nest egg will last throughout your retirement, but you also don't want to be at risk of losing a substantial portion of your portfolio if the economy goes bad.
The exact mix of assets that is right for you depends on a few factors, such as the size of your portfolio relative to your income requirements and how old you'll be when you retire. For example, if you need $50,000 in annual income and you have a $1 million portfolio, you'll probably need to take some risk to achieve that income throughout retirement. And if you retire early, you'll want to take extra caution, as your money will need to last through a longer retirement.
There is no magic mix of stocks and fixed income for new retirees, but you'll want to have significant exposure to both. The stock portion of your portfolio should be in a diverse basket of high-dividend, low-volatility stocks (or stock funds) with a long record of raising their dividends. Consider companies such as AT&T or ExxonMobil, which pay respective yields of 5.3% and 2.8% and have increased their dividends for 29 years and 31 years, respectively.
Fixed-income investments should consist of a mix of high-quality bonds (or bond funds) with various maturity dates. However, use caution when choosing bonds with long maturities, as these get hit hardest when interest rates rise.
This combination of rock-solid dividend stocks and predictable fixed-income securities should produce decent income while still allowing your investments to grow over time. And both types of investments are relatively low-risk, so you'll be able to sleep well at night.
You'll also want to adapt your portfolio to changing market conditions. For example, if interest rates jump through the roof and investment-grade bonds start to yield 8% or so, it may be a good idea to shift some of your money out of stocks and lock in those high rates for years to come.
Don't rely on "withdrawal rules"
An oft-cited piece of advice by retirement experts is the so-called "4% rule." Basically, this says you should withdraw 4% of your retirement savings during your first year of retirement and give yourself cost-of-living increases to keep up with inflation in subsequent years. The idea is that if you follow this rule, your money should last throughout your life.
The problem with this is that you'll need a different amount of money in every year of your retirement. For example, healthcare costs can vary dramatically from year to year, and they tend to take up a growing portion of our spending as we age. Maybe you know your grandchild is going to college in a few years and you plan to help with tuition. . It's best to anticipate changing expenses throughout your retirement, so plan your withdrawal strategy accordingly.
Further, the market performs differently from year to year. Even if your money is in fixed-income instruments, the value of those investments will rise and fall as the market fluctuates, so you may find yourself having to cut back during tough years. For a basic example, let's say your portfolio is worth $1 million when you retire, so you decide to withdraw $40,000 during your first year of retirement, leaving $960,000 in your account. Let's also say that the market has a bad year and the value of your portfolio drops by 5% during that year to $912,000. Instead of taking out another $40,000 the next year, it might be a good time to cut back your spending (temporarily) to, say $30,000.
By doing so, you'll leave more money in your account to take advantage of the eventual market rebound, and your money will be more likely to outlive your retirement. And this advice goes both ways: If the market has a good year and your portfolio rises by 5%, you may decide to take out a little extra to treat yourself.
Your withdrawal strategy needs to adapt to changing market conditions and adjustments in your expenses from year to year.
Don't start collecting Social Security without running the numbers
Americans can begin receiving Social Security benefits as early as age 62 and as late as age 70. While this eight-year window may not sound like a huge time frame, your choice of when to claim benefits can make a big impact on the amount you receive throughout your lifetime. This should definitely be taken into account when planning your income requirements in retirement.
Let's say that your estimated Social Security benefit at full retirement age -- between 66 and 67 for most of today's prospective retirees, as defined by the SSA -- is $1,000 per month, or $12,000 per year, and that you've decided you'll need a total of $60,000 per year to live comfortably after you retire. If you begin collecting benefits as soon as you're eligible at age 62, this amount would drop to about $750 per month, and you would need to withdraw $51,000 per year from your savings in order to bridge the gap. On the other hand, if you wait until age 70, your benefit could rise to $1,320. This means that only $44,160 of your $60,000 income requirement would need to come from your investments.
The bottom line is that, whether you have a $50,000 investment portfolio or a $50 million one, you need to adjust your post-retirement strategy to fit your own life. More importantly, your strategy needs to be adaptable to your changing lifestyle, as well as changing market conditions.
