subject: Allocate Your Investments More Conservatively As You Approach Retirement Age [print this page] Sticking to your retirement plan as you approach your retirement date includes timely investment allocations to help assure you achieve your goals. That's because you can't recover from downturns when you get too close to your retirement. John and Jean forgot that and suffered for it. Here's what happened.
John and Jean both managed to save well during their working careers. They had created a business together, eliminated all their debt, and managed to build up $750,000 in investments.
They were planning to retire in just 6 years. Their original savings goal was $1,000,000 and figured at 5% earnings it would give them $50,000 per year - or about $4,170 per month. Along with their Social Security benefits, that $4,170 would help to make a comfortable retirement for them.
*Disastrous Downturn:
Where they went wrong is that they left all their savings invested in stocks. Investing in stocks had done well for them over their long working years, so they were eager to let things ride. But then the market crashed leaving them with only $450,000 - only 60% of what they had before the crash.
Though John and Jean had planned a retirement target date and a savings goal, they lost track of safeguarding their goal with proper allocation of their investments. Indeed, they should've recognized that with only a 5% growth rate per year, their $750,000 would achieve their savings goal in the remaining 6 years to their retirement date. But they forgot to take steps to ensure that they weren't so vulnerable to downturns with so little time left to recover. They should have reallocated to a more conservative - and resilient - portfolio.
Allocating your savings means dividing them between unlike investments - investments that generally respond differently to the market. Typical allocations are between stocks and bonds. Typically, you're looking for appreciation in stock values but only interest income with bonds. The latter investment is more secure since you can recover your principal by picking an appropriate term.
Your purpose of allocating is to minimize your savings' vulnerability to market downturns, yet allow you to share in market growth too. The fraction you allocate to different investment types changes as your target date approaches. Shorter investment times means less time to recover if the market turns down. So as you approach your retirement date shift allocation fractions away from stocks toward bonds since the latter are less vulnerable to stock market swings.
*An appropriate allocation to minimize downturn losses:
With about 6 years to their target date, John and Jean should not be 100% invested in stocks. An appropriate allocation might be 60% stock and 40% bonds. In fact they should have some 5% of their savings in cash equivalents too.
Suppose they had taken that $750,000 and allocated only 60% ($450,000) to stocks, 35% ($262,500) to bonds and 5% ($37,500) to cash. So, when stocks loss 40% of their value in the crash, John and Jean would have lost only $180,000 (i.e. 40% of $450,000). They'd be left with holdings of $570,000 (i.e. $270,000 in stocks, $262,500 in bonds, and $37,500 in cash) - a 24% overall loss in their investment. Not great but a lot better than before.
An appropriate allocation won't guarantee you'll suffer no loss in savings if markets head south. But taking a 24% loss under a more proper allocation beats the 40% loss that John and Jean took for being fully invested in stocks. The better allocation would have increased their prospects of recovery. And its 'after crash' allocations (in parentheses) would suggest reallocating again by buying stock at their depressed prices. Doing that could enhance recovery and shorten their 'new' time to retirement.
