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Make Room for Equities

Make Room for Equities
STOCKS OFFER LONG-TERM GROWTH POTENTIAL BEFORE AND DURING RETIREMENT


A long-term investment strategy is an important component of building retirement savings. When you retire, your investment priorities may not change as much as you anticipated. Because your retirement may last 20 to 30 years, stocks will still belong in your portfolio. To ensure that you don't run out of money during that period, your investment mix will have to provide stable income without sacrificing long-term growth.


TIME AND RISK TOLERANCE During your working life, the stock market's ups and downs may have little or no financial impact on your daily life. You can ignore them by reminding yourself that you won't need to start spending your retirement savings for a long time; and you can compensate for down years by boosting your contributions. But in retirement, market drops can reduce your current income; compensating for down years may mean spending less. As a result, many experienced investors become less risk tolerant in retirement.


THE ONGOING THREAT OF INFLATION Despite risks, retirees can't afford to abandon stocks, because they're the only asset class that historically has outpaced inflation. A healthy 65-year-old can expect to live another two or three decades,* and over the course of those years, even a 3.5 percent average annual inflation rate can dramatically cut the purchasing power of a dollar (see chart at right).


A NEW STRATEGIC APPROACH Before and during retirement, you'll still rely on diversification and asset allocation to help manage investment risk. But when you begin living on your portfolio savings, you'll need a new approach to balance the trade-off between protecting your money and growing it. Since you'll be spending your savings gradually, over time, one solution is to allocate your portfolio by spending horizon as well as by asset class.


If you can invest enough assets in cash and conservative income-producing investments to cover up to five years' worth of your living expenses, for example, you'll greatly reduce the risk that you'll be forced to sell stock investments in a down market to meet your immediate cash flow needs.

Moderate-risk assets, such as intermediate-term bonds, offer the next layer of protection'money you can tap if necessary after you've spent your cash assets. Finally, more aggressive-risk investments'like large-cap stocks, foreign stocks and small-cap stocks' are allocated for the long term.


Alternatively, you could invest in broadly diversified asset allocation funds to achieve the same strategy, by dividing your portfolio among conservative, moderate and aggressive-growth funds.


Periodically throughout your retirement, you can adjust your allocation by shifting money from the more-aggressive to more-conservative investments.

What to Consider When Choosing a Withdrawal Rate

Conventional wisdom has long advised taking annual withdrawals no greater than 4 percent of your savings at the beginning of retirement, adjusted yearly for inflation.

But the 4 percent method doesn't adjust for market fluctuations. That's why some advisers recommend taking withdrawals based on life expectancy, as shown on IRS actuarial tables for determining required minimum distributions (RMDs) from tax-deferred retirement accounts. Although RMDs don't start until you're older than age 70½, the IRS publishes life expectancy numbers for younger ages. Depending on your health and your family's health history, you could use the IRS Single Life Expectancy Table, which puts a 70-year-old's life expectancy at 17 years (i.e., living to age 87), or IRS Table III, which puts a 70-year-old's life expectancy at 27.4 years (living to age 97.4).**


With the table method, your annual withdrawal is your nest egg's balance on December 31 of the previous year, divided by your life expectancy. You can use the Janus RMD calculator at janus.com/rmd to do this calculation.

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The Impact of Inflation Over Time

Although annual inflation may seem negligible, it's a serious threat to your financial security in retirement. Assuming a 3.5 percent average yearly inflation rate, here's how much money you'll need to retain the buying power of $40,000 over time: