Think of an investment portfolio as a basket that contains all the investments you have in your various (taxable) retirement and non-retirement accounts. Ideally, your portfolio grows with you and provides you with the income you need to live comfortably through your post-work years.
If you’re saving for retirement and investing for retirement, make sure your portfolio has these key characteristics.
Key points to remember
- An ideal portfolio should contain a growth component, especially in your younger years.
- Later in life, the focus shifts from growth to income.
- Regardless of your age, it’s essential to diversify and rebalance your portfolio as your goals, risk tolerance and time horizon change.
Investing after the golden age
What is an investment portfolio?
An investment portfolio includes all of the investments you hold in various accounts, including:
- Employer-sponsored plans like 401(k)s
- IRA (Traditional, Roth, SEP, SINGLE)
- Taxable brokerage accounts
- Robo-advisor accounts
- Cash in savings, money market accounts or certificates of deposit (CD)
These accounts may contain different types of assetsincluding (but not limited to) stocks, bonds, exchange traded funds (AND F), mutual fund, goods, futures contracts, choice, and even real estate. Together, these assets form your investment portfolio.
If you’re investing for retirement, an ideal portfolio would be one that meets your financial needs for the rest of your life. The following features contribute to this.
Pension plans are designed to grow over long periods of time. Growth instruments as equities and real estate generally form the core of the best performing retirement portfolios, at least when they are in the growth phase.
It is extremely important that at least some of your retirement savings grow faster than the rate of inflation, which is the rate at which prices increase over time. This allows you to increase your purchasing power over time.
Data from Kiplinger.com shows that stocks have posted the best returns of all by far asset class overtime. From 1926 to 2018, stocks have averaged growth of around 10.1% per year.
For this reason, even pension portfolios that are largely focused on Capital preservation and income generation often maintain a small percentage of equity holdings to provide a hedge against inflation.
The amount of average annual growth in stocks between 1926 and 2018.
Diversification will take a different form over time as you approach retirement age. When you are in your twenties, you may only need to diversify your portfolio among different types of stocks, such as large, mid and small cap stocks and funds, and maybe real estate.
However, once you reach your 40s and 50s, you will likely need to move some of your holdings into more conservative sectors. These include corporate bondspreferred stock offerings and other moderate instruments that can still generate competitive returns, but with less risk than pure stocks.
Alternative investmentssuch as precious metals, derivatives, oil and gas leases and other non-correlated assets can also reduce the overall volatility of your portfolio. They can also help generate better returns during times when traditional asset classes are inactive.
An ideal retirement portfolio also won’t be too dependent on company stock held inside or outside of your 401(k) or other stock purchase plan. A sharp drop in value could drastically alter your retirement plans if it makes up a large percentage of your retirement savings.
Once you have reached or are close to retirement age, your risk tolerance changes oftenand you may need focus less on growth and more on capital preservation and income. Instruments such as certificates of deposit (CDs), Treasury securitiesand fixed and indexed annuities may be appropriate if you need a capital or income guarantee.
As a general rule, however, your portfolio should not be invested exclusively in guaranteed instruments until you reach your 80s or 90s. An ideal retirement portfolio will take into account your withdrawal risk, which measures how long it will take you to recover from a significant loss in your portfolio.
Active vs passive management
Investors today have more choice than ever when it comes to who can manage their money. One of these choices is active vs passive portfolio management. Many planners exclusively recommend portfolios of index funds which are passively managed.
Others offer actively managed portfolios that can show higher returns than broader markets and with less volatility. However, actively managed funds generally charge higher fees, which is important to consider, as these fees can erode your investment returns over the years.
Another option is a robo-advisor, which is a digital platform that allocates and manages a portfolio according to predefined algorithms triggered by market activity. Robo-advisors generally cost much less than human managers. Yet their inability to deviate from their programs can be disadvantageous in some cases. And the business models they use are generally less sophisticated than those employed by their human counterparts.
Robo-advisors may not be the best choice if you need advanced services such as estate planning, complicated tax management, trust fund administration, or retirement planning.
Conceptually, most people would define an “ideal” retirement investment portfolio as one that allows them to live in relative comfort after leaving the workforce.
Your portfolio should always contain the appropriate balance of growth, income and capital preservation. However, the importance of each of these characteristics is always based on your risk tolerance, your investment objectives and your time horizon.
In general, you should focus your portfolio primarily or entirely on growth until you reach middle age, at which time your goals may begin to shift toward income and risk reduction.
Yet different investors have different risk tolerances, and if you intend to work to a later age, you may be able to take more risk with your money. The ideal portfolio therefore always depends on you and what you are willing to do to achieve your goals.