The need for retirement planning doesn’t end with the onset of retirement. A new retiree’s focus shifts from building wealth to managing and preserving it. One major challenge is to make the investment portfolio supply cash flow for the duration of life – and through different economic and market conditions.
Three main factors drive portfolio endurance: asset mix, spending level and investment time frame. Certain aspects of these factors are within an investor’s control while others are not. Let’s briefly consider them.
Asset mix: Asset mix describes the ratio of stocks to bonds in a portfolio. This determines risk exposure and expected performance, and is one of the most important decisions investors of all ages can make. Historically, stocks have outperformed bonds and outpaced inflation over time. Growth can bring higher cash flow, inflation protection, and portfolio endurance over time. The allocation should be customized to one’s time frame, risk tolerance and spending flexibility.
Spending level: Portfolio withdrawal is typically described in terms of a specified dollar amount (e.g., $50,000 per year) or a percent of annual portfolio value (e.g., 5 percent of assets each year). Retirees who need relatively consistent cash flow may want to combine these two methods.
- Specified dollar amount: withdrawing a fixed amount each year and adjusting it for inflation can provide a stable income stream and preserve your living standard.
- Percent of annual portfolio value: withdrawing a fixed percentage of assets based on annual asset value makes it unlikely that you will deplete retirement assets because a sudden drop in market value would be accompanied by a proportional decline in spending.
Investment time frame: Investment time horizon may be the hardest to estimate, especially if it is the same as your lifespan. In this case, you can only guess how long your portfolio must support spending.
Considerations: Planning involves assumptions about the future – assumptions that may not pan out. Although you cannot avoid making assumptions, you can ask whether they are realistic or not.
Finally, although you cannot fully control these and other factors involved in portfolio endurance in retirement, having more wealth can improve the odds of having a less stressful financial life.