Retirement is when investing gets particularly tricky because the portfolio that brought you to the retirement party won't be the one taking you home.
Near-retirees and those already in retirement need to engineer their investments to mitigate factors that can lead to portfolio failure.
A successful retirement portfolio is one that outlasts you -- or at least lasts as long as you do. A portfolio failure means you've run out of money before you've run out of life.
Factors that contribute to portfolio success or failure include:
The withdrawal rate
To fund 30 years or more of retirement, a person should have saved, at minimum, between six and 10 times their annual pay, ideally within tax-favored accounts.
Before divvying up the pot of money into asset classes, the first step is to determine the amount of income needed from the portfolio on an annual basis.
Ideally, the amount needed annually should not exceed about 4 percent of the portfolio. Past research has suggested that a withdrawal rate of 4 percent every year is generally considered to be safe. Subsequent research has pegged the safe withdrawal rate somewhat lower, but the 4 percent rule of thumb persists.
Recent simulations run by Manoj Athavale and Joseph M. Goebel, professors at the Miller College of Business at Ball State University, found that a 4 percent withdrawal rate for 30 years resulted in portfolio failure 14 percent of the time. When the withdrawals spanned a 35-year period, the failure rate increased to 18 percent. If your income needs exceed about 4 percent of the portfolio per year, an aggressive investing strategy may be able to make up for some savings shortfalls, but miracles and the stock market do not generally go hand in hand.
Asset allocation and investing strategy
Even in trying to make up for a savings gap, retirees and people close to retirement shouldn't invest as heavily in stocks as they did during their working years. In fact, they should move to limit their exposure to the stock market to a certain extent.
"If someone is only going to work for 10 or 12 years (before retiring), there are a finite number of years in which we could recoup the volatility in a portfolio. We might start with a portfolio that has as much as half of the assets in fixed income and half in the equities," says Dan Yu, managing director of EisnerAmper Wealth Advisors in New York City and lead retirement expert.
Over time, the effect of market volatility can be pernicious in a retirement investment portfolio without a strategy to deal with it.