If you recently retired or are planning to, you likely have questions about how to position your investments going forward. Conventional wisdom suggests investors should change their asset allocation in retirement to be more conservative. However, depending on your pre-retirement asset allocation, income sources/needs, and long-term goals, that may not be advisable. Here are a few things to consider as you think about how to get your portfolio retirement-ready.
How should you adjust your asset allocation in retirement?
While there’s no magic bullet that’s right for every situation, there are several thigs to keep in mind as you consider your retirement portfolio. This includes revisiting popular, and at times antiquated, investing ideas.
Reconsidering the 60/40 portfolio
Markets change over time. People live longer. Interest rates don’t stay stagnant. Correlations among asset classes shift. Employer benefit plans change, often shifting retirement risk to the employee. These are just a few of the factors that make professional asset managers call the traditional 60/40 retirement portfolio into question.
For example, consider how falling interest rates have affected bond returns over the last several decades. Back in the 80s, bond returns were really robust. Granted, inflation averaged about 6% and mortgage rates were sky-high, but since then, interest rates (measured by the 10-year treasury in the chart below) and bond returns have been on the decline.
Source: BlackRock
BlackRock
Over the last 10 years (ending 9/27/2021), bonds¹ produced a 3.08% average annual return. Inflation² was about 2% on average. In another words, fixed income returns barley kept pace with inflation, before tax. New retirees may need their portfolio to last 40 years, which can be difficult to do if their asset allocation in retirement is based on decades-old rules of thumb.
Living off portfolio income can be hard to do
Many investors want to live off the income from their portfolio instead of dipping into principal. Sounds great, but it’s harder than it looks.
As the table from J.P. Morgan illustrates, since the 1990s, dividends began to make up a smaller portion of the overall total return of the S&P 500, relative to the prior decades.
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management; Ibbotson; Dividend vs. capital … [+]
J.P. Morgan Asset Management
If you’re wondering how dividend yields translate into retirement income, here’s a simple example. As of the writing of this article, the dividend yield for the S&P 500 is 1.4%.³ So if you have a portfolio of $1,000,000, that imputes annual dividend income of $14,000. Unless you have a pension or other source of income, it’s highly unlikely that dividend income alone will provide enough income in retirement. Especially after paying tax!
As you consider how to adjust your asset allocation in retirement, consider how different asset classes and sectors may be able to boost retirement income. And make sure you’re building a retirement spending plan within your means to help ensure you don’t run out of money. As always, understand the risk/reward framework before investing.
For example, value stocks typically offer higher dividend income relative to growth stocks. They can, however, be more volatile. So, in addition to income, you’ll also want to consider other factors, such as correlation with other asset classes, risk-adjusted returns, and sensitivity to interest rates and the overall economy.
Who are you investing for?
Not all retirees are investing for the same thing. Some investors must fully focus on maintaining their lifestyle without running out of money. However, for wealthier retirees, that may not be much of a concern. Instead, these individuals may be mentally earmarking some of their portfolio for the next generation.
When contemplating whether you should change your asset allocation in retirement, consider all your goals and full time horizon. For example, individuals typically shouldn’t take on more risk than necessary to achieve their goals. But if one of those goals includes leaving an inheritance to adult children, then it probably wouldn’t make sense to invest ultra-conservatively, as the portfolio may ultimately be invested for beneficiaries who have a much longer time horizon.
Consider your whole situation
Developing an asset allocation must be done with your entire personal situation in mind and an understanding that rules of thumb can be misleading. For example, consider a couple who has significant pension or Social Security benefits relative to their income needs. In one interpretation, they probably don’t require as much upside from their portfolio to outpace inflation. On the other hand, because they don’t need to rely solely on their portfolio to meet basic needs, they could possibly ‘afford’ to take on greater investment risk, perhaps to leave a legacy to their children or grandchildren if so inclined. It’s complicated because there’s no one right answer for every situation.
¹ Bloomberg Barclays U.S. Aggregate
² U.S. Core CPI, seasonally adjusted, year over year
³ Dividend yield is calculated as consensus estimates of dividends for the next 12 months, divided by most recent price, as provided by Compustat. Forward price-to-earnings ratio is a bottom-up calculation based on J.P. Morgan Asset Management estimates. Data as of 9/27/21.