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How do I invest when I'm 2 years away from retirement?

December 03, 2015

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Q: I am 60 years old and plan to retire at 62. Because Social Security would not be enough to live on, I plan to invest some money from my 401(k) in order to have some extra income. Could you advise on an investment product?

A: Your question touches on two key issues that go a long way to determining what type of investment product you should consider: time horizon and withdrawal rates. In addition to looking at those considerations, it might also be worth revisiting your Social Security strategy.

Time horizon

It is easy to assume that being two years from retirement equates to a fairly short investment horizon. However, before you retreat completely to certificates of deposit (CDs) or savings accounts, keep in mind that your actual time horizon is probably closer to 25 years than two years. This is because your probable life span means you should be investing for a long time to come. It might be wise to keep some growth element in your 401(k) plan, perhaps in a balanced stock/bond portfolio, especially since that plan is complementing Social Security payments, which effectively have the characteristics of an income investment.

Withdrawal rate

If you plan to withdraw money from your 401(k) at a low percentage rate - say 4 percent or less - you should be able to sustain your balance without rapidly drawing it down. This would allow you to assume a longer time horizon and invest more aggressively. However, a higher rate of withdrawal is likely to draw your balance down more rapidly. This effectively shortens your time horizon, pointing you towards more conservative investments for liquidity reasons. The problem is, with rates on savings accounts near zero and even 30-year Treasuries barely yielding 3 percent, this will greatly lower your return potential.

One other thing about withdrawals - if you regularly draw a fixed dollar amount from retirement savings and start to draw your total balance down, that dollar amount will become a larger and larger percentage of your remaining balance. This in turn will hasten the drawing-down process.

Social Security strategy

One final thing to consider is whether you should delay drawing on Social Security to receive larger payments in a few years. If you can continue to work, it would also give you a few more years to build up retirement savings, and fewer years over which you will have to draw on those savings.

When putting this all together, keep in mind that as your money leaves your 401(k) it will become taxable. Try to withdraw no more than you will need from year to year, so you don't incur taxes any sooner than is necessary. For that reason, the first step in your process might be to formulate a retirement budget, to see how much money you will need to live on.

From there, you can figure out the rate of withdrawals you'll be taking from your 401(k) plan, and that in turn should give you an idea of how aggressively you can afford to invest.

Comment: Are you close to retirement age? How do you plan on investing your money?

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