The market might be enjoying record highs, but investors are increasingly committed to their cash. And that includes retirees.

A recent report from State Street's Center for Applied Research shows that investors are leaning in the direction of cash allocation. In part, that means they're opting for perceived security, holding on to their money in case of potential market changes. But it also means that many of them are giving up the returns that higher-risk instruments can provide.

It's the kind of data that shows how retirement planning can slip out of balance. Striking an optimal balance means having cash reserves for emergencies but also investing in high-quality assets so your portfolio beats inflation. Our current love affair with cash might well be cutting into that goal.

So let's look at the numbers in the report and then discuss some key ways to lift your retirement account out of the low-return zone where cash-heavy portfolios tend to sit.

Are your assets askew?
The State Street report indicates that in the U.S., investors skew their assets toward cash allocation, which amounts to an average of 36% of their holdings.

And investors over the age of 67 -- the demographic most often associated with recent retirees -- are socking away 43% of their assets in cash. Interestingly, the emphasis on keeping money at hand doesn't dwindle much as the demographic gets younger, either:

  • Baby Boomers allocate 41% of their assets to cash.
  • Generation X allocates 38% to cash.
  • Millennials allocate 40% to cash.

Is it a problem for retirees to have more than a third of their assets in cash? Yes, if you want your portfolio to grow at a pace that mitigates inflation and covers your costs of living for the decades you'll draw on it after leaving work.

Relying too much on cash means overemphasizing one kind of risk while turning a blind eye to another. We worry about losses when it comes to investing. We often think of equity investments as volatile -- and they can be -- and most individuals would prefer fixed income over unexpected changes.

But retirees also have to consider a different risk: losing to inflation. Stuffing the mattress, as it were, might satisfy our affinity for steadiness and an immediately at-hand balance. But the purchasing power of that money almost always dwindles over time -- though it can do so at such an imperceptible rate that it takes 20 to 30 years to notice the effect.

So how do we strike a balance? Let's turn to a three-step approach to keep your money safe from sudden market changes but also meet your retirement needs over time.

The right blend of safety and growth
Cash can be just the thing when one needs to ride out a market downturn without having to sell, sell, sell. Yes, a cash buffer can allow your stocks to recover, but it's important to divvy up resources so that the potential drawbacks of a cash reserve don't outweigh the advantages.

Let's discuss three steps to help you do just that, thinking of each portion of your portfolio as a bucket that you need to fill.

  • Bucket No. 1: cash reserve. If you're drawing on a pension or an annuity, your annual income as a retiree could already be sufficient. From there, start to separate some cash into a reserve that can cover your living expenses in the case of an emergency. Many people aim to set aside six months' worth of living expenses. However, to get your assets into a position where they can create some tangible change in your portfolio, map your way to accruing two to three years' worth of annual withdrawals in reserve, splitting those assets between cash and short-term, high-grade bonds. Now you can begin to worry less about bear markets, enjoy some modest growth in the reserve you've just built, and also turn to the next step of a strategy that prompts further growth.
  • Bucket No. 2: safe and steady investments. After you've filled bucket No. 1 with reserve funds, the goal is to fill the next with a relatively non-volatile mix of stocks and bonds. You reach into bucket No. 1 at times to do that, but bucket No. 2 will reap returns that allow you to periodically replace -- and even increase -- your safety funds.
  • Bucket No. 3: growth investments. Next, it's time to think about long-term growth. While bonds have helped balance the blend in bucket No. 1 (with cash) and bucket No. 2 (with some stocks), bucket No. 3 will mostly contain stocks. When you have gains from bucket No. 3, you can siphon those returns into bucket No. 2 -- and even all the way back to bucket No. 1. The contents of this third bucket are more susceptible to market swings, so sometimes you'll see a loss, but remember that you have a reserve tucked away, and the exposure from bucket No. 3 is only a part of a blend of instruments for your continued retirement income.

Of course, planning for retirement is initially about how to bring together the assets you need in the first place.

The strategies we've just considered are about building assets over time once you've left work. You don't need to put them into practice at light speed. Shift gradually from a fixed-income scenario, graduating your allocations from cash to bonds to stocks as each step proves successful and you begin to see gains replace the cash you spent to earn them.

Remember that every retirement blend is an individual recipe, so learning to mix yours is about adding and subtracting in increments. You'll know you have it right when you're outpacing inflation, growing your savings over time, and sleeping soundly at night.

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