You'd expect Tim McCarthy, the former president of Charles Schwab and the author of "The Safe Investor," to have the perfect retirement portfolio.
You'd be wrong.
After writing a piece about retirement plans, McCarthy decided to check on his own. "Sure enough, I didn't have nearly enough equities in my retirement plan," he said. Instead, his stocks were in his taxable accounts, and if he sold them to rebalance after the recent run-up, he'd owe taxes.
Few people reach retirement with perfectly geared 401(k)s and IRAs. Only about 45 percent of all workers have current access to a retirement plan at work at all, according to the Washington, D.C.-based Employee Benefit Research Institute. But if you do have one, chances are good you have more than one.
The nature of the employment system is that people accumulate accounts as they change jobs, and they often end up with a hodgepodge of investments that leaves them vulnerable to risk of all kinds, including a portfolio that's so volatile it could take a dip just when you need the money, a portfolio that is so conservative you lose to inflation, or a portfolio that is not optimized for taxes.
A snapshot of the U.S. retirement market tells the story. Of the $23 trillion in retirement assets, more than half is in 401(k)s and IRAs, and the rest is in defined benefit plans, annuities, state and local pension plans and an array of other financial vehicles, according to the Investment Company Institute's most recent 2014 Fact Book.
Just beginning to think about what you need to do may be the hardest step. If you're in your 50s, you might be stuck in what McCarthy calls the "dead leaf" syndrome. You're looking ahead to a time when you're no longer needed. To avoid feeling like a dead leaf about to be swept to the curb, you might be tempted to ignore your retirement portfolio altogether. That would be a mistake.
Ignoring your portfolio could come at a high cost if history catches you at the wrong moment. At the end of 2007, investors were woefully weighted with stocks, according to the Employee Benefit Research Institute. Nearly 1 in 4 Americans ages 56 to 65 had more than 90 percent of their account balances in equities at year-end 2007, and over 2 in 5 had more than 70 percent. Equities declined nearly 40 percent the following year, wiping out billions in retirement savings for many retirees. It forced many near-retirees to delay stepping out of the workforce.
The typical retirement-age couple walks in the door with portfolios overweighted in equities, said Tim Maurer, director of personal finance for the St. Louis BAM Alliance, which represents 142 independent investment advisers nationwide. "Typically, we are dialing it back," he said.
Now, as the economy hums along and the market rises, it is a good time to bulletproof your portfolio against the volatility that can strike at any time.
1. Figure out what you need. Any financial adviser worth his or her salt will tell you that as you enter your 50s, you need to have a firm idea of the budget you'll need in retirement, so before you begin bulletproofing, have a clear sense of your required monthly income. The typical household made up of Americans in the 55-to-64 age range has accumulated only enough retirement assets — $120,000 — to produce $400 to $500 of income a month to add to Social Security payments, according to the Federal Reserve's Survey of Consumer Finances. The typical Social Security benefit is $1,887.
2. Save more, and extend your working life. The biggest lever you can use to bulletproof you retirement portfolio is to put more money into it, which you can do by saving more. And the simplest way to do that is to work longer. Suppose you need $80,000 a year in retirement. If you can continue to earn $100,000 a year for five years past your expected retirement date and put aside $20,000 or $30,000 of that a year, you will have added a total of six to seven years of income to your portfolio. You can also increase your Social Security benefit 76 percent a month by delaying your claim from 62 — the earliest year you're allowed to claim — to 70.
3. Diversify. If you want to lower the volatility of your portfolio, diversify within and among asset classes. That means owning funds instead of individual stocks, and owning multiple asset classes instead of just one: a portfolio of emerging markets stock and bond funds, plus domestic stock and bond funds. As always, keep your fees low.
Vanguard projects returns for a balanced portfolio of 60 percent stocks and 40 percent bonds over the next 10 years to range from –3 percent to 12 percent, with the most likely scenario between 1.5 percent and 7.5 percent a year on an annualized basis. You can either diversify your own portfolio or buy a good low-cost target date fund. Vanguard offers some; Fidelity Investments offers the Fidelity Freedom Index Funds, which are similar. Just remember: in order for a target date fund to work properly, your whole retirement account balance needs to be in the fund.
4. Design your asset allocation with an eye to taxes. If you have significant holdings outside your retirement accounts, think through which asset classes belong in your retirement account. You'll save significantly on taxes if you keep the equities — which you may buy and sell more frequently as you rebalance — in your retirement portfolio. But don't make your portfolio decisions around your tax savings; maximizing your investment returns and keeping your principal safe is a higher priority, McCarthy said.
5. Keep a healthy portion of equities. Don't make the mistake of getting rid of all of your equities and shifting into money market funds because you think they are safer. "You could move too conservatively," said Maria Bruno, senior investment analyst at Vanguard. If you look at the returns of equities and cash every year since 1926, she said, equities lost value in a third, but on a real basis, cash lost money in a third of the years, too, because of inflation. Most experts recommend that in retirement you have at least a 20 percent allocation to equities. If you have nerves of steel, you can keep much more than that in equities.
6. Relax and set yourself up for automatic rebalancing. You'll be retired for a long time, so in order for your money to keep working at the highest possible pace, you need to continue selling high and buying low, which is what rebalancing automatically does for you. A target date fund will rebalance automatically; so will a number of online options and investment advisers. Ask at yours.