Focus on growth now and income later
Imagine your numerous retirement plans and taxable accounts as a basket that contains your whole financial portfolio. Your portfolio should increase in value over the course of your working career in order to be able to give you the income you require to retire comfortably.
Read on to learn the fundamentals about how to set up an investment portfolio for retirement if that is your objective.
What Is an Investment Portfolio?
All of your investments across all of your accounts are combined into a portfolio, which includes the following:
The assets that can be held in those accounts range from equities and bonds to exchange-traded funds (ETFs), mutual funds, commodities, futures and options, and even real estate. These resources make up your portfolio of investments as a whole.
A portfolio that is created to cover your financial needs for the rest of your life once you leave the working would be great if you are investing for retirement.
In order for your returns to compound over time and increase the value of your portfolio, you must start saving money and investing as early as feasible. Giving your money the best chance to compound ensures that it genuinely works for you over time.
Focusing on a significant portion of growth investments in your earlier years is another requirement of a perfect retirement portfolio. Such an investment is equity, and growth stocks in particular.
Retirement plans are made to assist investors in increasing the value of their holdings over a considerable amount of time. During the growth phase, growth assets like stocks and real estate often form the foundation of the most prosperous retirement portfolios.
It is essential that at least a portion of your retirement funds outpace inflation, which is the rate of increase in prices over time. The loss of buying power brought on by inflation can be halted by investments that increase faster than the rate of inflation.
By far the best returns of any asset type over time have been achieved by stocks. The average annual growth rate for large-cap stocks from 1926 to 2022 was 10.1%. Average small-cap stock returns were 11.8%. Government bond yields were only 5.2% on average, while cash growth was 3.2%.
Due to the need to provide some growth potential and an inflation hedge, even retirement portfolios that are primarily focused on capital preservation and income generation frequently keep a small percentage of equity assets.
Including many asset classes and investment vehicles is referred to as diversification, which is done to reduce the impact of risk and poor performance of any one asset. With time, diversification will take on new forms. In your 20s, you might choose to diversify your portfolio by including several kinds of stocks and funds, such as large-, mid-, and small-cap companies, as well as possible real estate investments.
Yet after you’re in your 40s and 50s, you might want to shift some of your assets into more traditional industries. Corporate bonds, preferred stock offerings, and other moderate (less aggressive) products that can nevertheless produce competitive returns—but with less risk than pure equities—fall under this category.
Alternative investments can help lessen your portfolio’s overall volatility, including precious metals, derivatives, oil and gas leases, and other non-correlative assets. Also, they can contribute to higher returns amid slumps in traditional asset classes.
Shares of company stock (owned in or out of your 401(k) or other stock purchase plan) shouldn’t make up too much of a retirement portfolio. If it makes up a significant portion of your retirement assets, a significant decline in its value could significantly affect your retirement plans.
Risk tolerance is the degree of price volatility that investor is ready to accept for their investments. Your risk tolerance may vary as you get closer to retirement, and you might need to put more of an emphasis on capital preservation and income rather than growth (equities) (fixed income securities).
If you require a guarantee of principal or income, instruments such as certificates of deposit (CDs), Government securities, and fixed and indexed annuities may be suitable.
Yet, until you are in your 80s or 90s, your portfolio shouldn’t be entirely comprised of guaranteed investments. Your drawdown risk, which quantifies how long it will take you to recover from a sizable loss in your portfolio, will be considered when building an appropriate retirement portfolio.
Active vs. Passive Management
Today’s investors have more options than ever for how to handle their money. Portfolio management options include active vs. passive. Several financial advisers exclusively suggest portfolios of passively managed index funds.
Some people advise investing in actively managed portfolios, which could produce returns that are higher than those of the broader markets. However, fees for actively managed funds, including transaction costs, are often greater. This is crucial to take into account because over time, those costs may reduce your investment returns.
A robo-advisor, a digital platform that manages a portfolio in accordance with predetermined algorithms triggered by market activity, is another choice. In general, robo-advisors are much less expensive than human managers. Yet, in other circumstances, their inability to veer from their plans may be a disadvantage. Additionally, their trading strategies may be less complex than those used by their human competitors.
What Is a Good Investment Portfolio for Retirement?
Your age and how soon you plan to leave the workforce will determine that. Go for an aggressive investment strategy that is heavily weighted in stocks while you are just getting started because historically, equities have outperformed fixed income investments. Market dips and decreases in the value of your portfolio can be recovered from over time. As your risk tolerance changes, you can take a more cautious attitude with your investments (e.g., as you near retirement). To protect against inflation and to ensure that you don’t outlive your money, always include a growth component in your portfolio.
What Should My Portfolio Look Like at 55?
To begin with, consider your risk tolerance at that age and how committed to growth you still need to be. When an individual is in their 60s, some financial consultants advise a blend of 60% stocks, 35% fixed income, and 5% cash. Thus, if you’re still employed and investing at age 55, you might think about that allocation or something with even more room for development.
What Is a Big Retirement Portfolio Mistake?
The worst error we might make when it comes to our retirement savings may be waiting too long to start saving and investing, like in our twenties. Making this error could prevent you from taking advantage of compounding’s remarkable ability to increase the value of your portfolio (without you lifting a finger). Compounding pays off financially most significantly over time.
The Bottom Line
The majority of people define an ideal retirement investment portfolio conceptually as one that enables them to live comfortably when they stop working.
A proper balance of investments for growth, income, and capital preservation should always be included in your portfolio. However, your risk tolerance, investing goals, and time horizon should always be taken into account when determining the relative importance of each of these factors.
Until you approach middle age, when your goals may start to move toward income and lower risk, you should generally concentrate your portfolio entirely or primarily on growth.
But, various investors have varying levels of risk tolerance. If you plan to work into your senior years, you may be able to face more financial risks. As a result, the best portfolio will always ultimately depend on you—and what you are ready to sacrifice to achieve your objectives.