A lot of retirement-investment advice focuses on how to build a nest egg over the course of your working career. But there is a completely different phase of retirement investment strategy to consider -- how best to preserve your assets through retirement.
As you go about investing for retirement, it's important to recognize that the finish line is not retirement itself. That's merely the start of the next phase of your retirement investment strategy, a phase which could last for decades.
It's also important to note that the right approach to this phase of your retirement plan depends greatly on your individual circumstances. Here's how to tailor your post-retirement investment strategy to your particular situation.
1. Understand longevity and inflation
One of the quirky things about retirement planning is that longevity is actually considered a risk. The reason is that, from a financial standpoint, a long life means having to stretch your dollars over more years. It also means that inflation has more time to take hold, and this combination of longevity and inflation are an important reason why retirees should not suddenly become overly conservative with their investments.
Over the past 50 years, inflation has risen at an average annual rate of just over 4 percent. That means that prices on average will roughly double every 17.5 years. Someone reaching retirement age could very easily live that long, and possibly much longer. So when you plan for your retirement needs, keep in mind that things might cost more than twice as much in the later years as they do when you first retire.
The general inflationary trend is exacerbated by the fact that older people tend to spend more on healthcare. Consumers generally devote 8.0 percent of their annual spending to healthcare, but this rises to 13.4 percent for people aged 65 or older -- and healthcare costs are rising faster than the general rate of inflation.
2. Plan for liquidity and growth
Because costs are likely to grow significantly over the course of your retirement, you need to keep some growth investments in your portfolio to give your assets a chance of keeping pace with your expenses.
The other side of the coin is that liquidity becomes much more important in retirement. If you are drawing money out of a portfolio, you need investments that won't fluctuate wildly in value and can be readily converted to cash. This means that more conservative investments such as savings accounts, CDs, and high-quality bonds will play a larger role after retirement.
The key is to remember that liquidity should not be the sole focus of your retirement investment strategy. You need to strike a balance between liquidity and growth.
3. Find the right glide path
That balance between liquidity and growth should be reflected in your asset mix (the relative proportions of conservative and growth investments in your portfolio).
Generally speaking, your asset mix should get more conservative as you get older. This isn't one single shift you make once you reach retirement age but a gradual transition to making more conservative investments over time. Financial planners often refer to this gradual shift as a glide path, like an airplane's descent toward a smooth landing.
There are rules of thumb about how to engineer such a glide path, such as, using your age as a benchmark for the percentage of your portfolio that should be in conservative investments. This is useful in the sense that it will shift you gradually into more conservative investments as you get older, but the same glide path may not be right for everybody.
Another way to determine your post-retirement investment strategy is to figure out your spending needs over the next 10 years and keep money enough to cover those needs in more conservative investments. The remainder of your portfolio can be in growth investments. This accounts for the fact that, if your expenses are low relative to your retirement savings, you can afford to be more aggressively invested.
The main thing to know about any glide path is that you need to adjust it at least annually. Pilots don't land their planes on autopilot and, given the length of many retirements, you should not assume that the course you set originally will remain the right one as your investment returns and living expenses change over time.
4. Prioritize by tax status
One final note on handling your retirement investments: Be sure not to give up your tax advantages too quickly.
Many people reach retirement with a mix of taxable and tax-deferred retirement savings. As you start tapping into your savings for your spending needs, take money out of your taxable savings first. That way you can continue to enjoy the benefits of tax-advantaged investment growth for as long as possible.
While traditional IRAs require you to start taking some distributions once you reach age 70 1/2, Roth IRAs do not have minimum distribution requirements. This allows you to preserve their tax benefits until you actually need the money.
In closing, the end of your working career is an important milestone, but it should not be thought of as the end of your retirement plan. You may very well have 20 or 30 years ahead of you, and it takes careful planning to preserve your retirement savings over such a long period of time.