How to Set Your Asset Allocation in Retirement

Retirement asset allocation is the strategy of managing your investments to balance retirement income needs with risk tolerance. Unlike your working years, when you may have favored aggressive growth, retirement typically calls for a more nuanced approach. You must consider multiple factors, such as your expected longevity, other income sources like Social Security, healthcare costs and your desired lifestyle. Finding this balance is essential for maintaining both your financial well-being and peace of mind throughout retirement.

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Balancing Risk, Reward and Income Needs in Retirement

Building the best retirement asset allocation comes down to balancing risk, reward and income generation.

In retirement, this balance takes a more conservative approach compared to the accumulation phase. Retirees need to prioritize capital preservation while ensuring their investments generate sufficient income and maintain some growth to keep up with inflation.

Holding a high percentage of equities leaves you susceptible to market volatility that can affect your savings. However, too few equities may result in inadequate growth to offset inflation.

Fixed-income investments play a central role in retirement asset allocation planning. One example is different types of bonds: U.S. Treasury bonds, municipal bonds, and high-quality corporate bonds typically offer lower risk and more predictable returns than stocks. Laddering bond maturities is one method that can help mitigate interest rate risk.

Allocating a sizable portion of a retirement portfolio to fixed income can provide a sense of stability, especially during periods of market downturns.

Using a Glide Path

A common strategy to achieve this balance is the glide path approach. This reduces equity exposure over time in favor of more stable assets, such as bonds and cash equivalents.

The Rule of 110 is a popular glide path rule of thumb that suggests allocating 110 minus your age to equities. The remainder goes to fixed income or other stable investments. For instance, a 70-year-old retiree might aim for 40% in equities and 60% in bonds or cash equivalents.

Of course, this is a basic rule of thumb. Individual factors such as risk tolerance, health and retirement goals should also be considered when allocating assets in retirement.

Under the Rule of 110, retirement asset allocations can look very different at varying ages.

Adjusting Your Asset Allocation Throughout Retirement

Asset allocation is not static and should be revisited regularly throughout retirement.

Factors like age, health status, life expectancy and changes in financial goals necessitate periodic reassessment. As retirees age, it is often advisable to shift to a more conservative allocation, with a greater emphasis on fixed income and less exposure to equities. This gradual shift can help protect savings from market volatility when funds are most needed.

However, retirees also need to be wary of being too conservative. With longer life expectancies, there is the risk of outliving one’s savings. An asset allocation strategy that adjusts in response to market conditions and personal milestones can offer a balanced approach, combining growth opportunities with income stability.

Addressing Longevity Risk

While fixed-income instruments like bonds can help retirees preserve their capital, growth-oriented assets like stocks also play an important role in a retiree’s asset allocation. That’s because they can help mitigate longevity risk, or the risk of outliving your savings.

According to the Centers for Disease Control and Prevention (CDC), the average American male lives to 76, while the average woman can expect to live until age 81. ¹ However, retirees may want to consider overestimating their life expectancies, especially if they are in good health, to reduce longevity risk. 

Depending on your age and health at retirement, you may consider planning for 30 years’ worth of withdrawals from your retirement accounts. This means that you’ll need a large enough nest egg to last you for years to come and a withdrawal rate that won’t deplete your savings while you’re still alive. 

The Bucket Strategy

The Bucket Strategy to retirement income planning helps retirees manage risks associated with market volatility. It can generate steady income and ensure their assets last throughout retirement by aligning investments with their spending timeline.

This approach divides a retiree’s assets into multiple buckets, each designed for different time horizons and levels of risk. Typically, the approach consists of three buckets:

• Short-term bucket: Holds cash or very low-risk investments, like money market funds or short-term bonds, to cover living expenses for the next one to three years. The goal is to provide liquidity and avoid selling investments during market downturns.
• Medium-term bucket: Contains moderately conservative investments, such as intermediate bonds and dividend stocks, to generate income and preserve capital over a three- to 10-year period.
• Long-term bucket: Includes growth-oriented investments like stocks, meant to outpace inflation over 10+ years and ensure financial security in later retirement years.

When markets are up, retirees can take gains from the long-term bucket and allocate them to the short-term or medium-term buckets to maintain stability. During downturns, they can use the funds in their short-term bucket to avoid selling investments at a loss.

Annuities

Purchasing an annuity is another way to potentially reduce or eliminate longevity risk. Annuities can provide guaranteed income for life, reducing the risk that retirees will exhaust their savings. There are different types of annuities, such as immediate, deferred and variable annuities, each with unique features that can be customized to fit a retiree’s needs. However, these products can be complex and have significant fees associated with them. 

Delaying Social Security

Lastly, delaying Social Security benefits can also help address longevity risk. Social Security benefits increase substantially when you delay claiming. For each year you postpone benefits beyond your full retirement age (up to age 70), your monthly payment grows by about 8%. This permanent increase can significantly boost your lifetime income if you live into your 80s or beyond. The enhanced benefit also provides inflation protection through annual cost-of-living adjustments.

Maximized Social Security benefits can establish a solid income foundation for your later years. This guaranteed income floor covers essential expenses regardless of market performance or economic conditions. When combined with other guaranteed income sources like pensions or annuities, delayed Social Security benefits help ensure your basic needs remain covered throughout retirement.

Asset Allocation Mistakes Retirees Make

One of the most common errors is shifting entirely to bonds and cash the moment you retire. While this feels protective, it ignores the reality that your portfolio may need to last 25 to 30 years. Inflation at even a modest rate will steadily reduce what your money can buy, and a portfolio without any equity exposure may not generate enough growth to keep pace.

The opposite mistake is equally dangerous. Keeping the same aggressive allocation you had during your working years does not account for the fact that you are now taking money out rather than putting money in. A 30% market decline when you are contributing every month is a buying opportunity. The same decline when you are withdrawing every month accelerates the depletion of your savings in a way that can be very difficult to recover from.

How you rebalance matters as much as the allocation itself. Selling stocks after a decline to bring your portfolio back to target locks in losses and defeats the purpose of holding a diversified mix. A more effective approach is to draw your spending from whichever asset class is currently overweight, giving the underperforming asset class time to recover.

Where you hold different investments across your accounts also affects your after-tax returns. Bonds and other income-producing assets generate interest that is taxed annually in a taxable brokerage account. Placing those same holdings inside a tax-deferred IRA shelters that income until withdrawal. Growth-oriented investments like stock index funds tend to be more tax-efficient and are generally better suited for taxable accounts.

Required minimum distributions catch many retirees off guard. Once RMDs begin, the IRS dictates a minimum amount you must withdraw each year from traditional retirement accounts. If your allocation in those accounts is heavily weighted toward equities, a down year could force you to sell stocks at depressed prices to meet the requirement. Holding enough in bonds or cash within your tax-deferred accounts to cover at least one to two years of RMDs gives you room to avoid selling at the worst possible time.

An allocation that made sense at 65 with two Social Security checks and good health may not fit at 75 with one check and rising medical costs. Reviewing your mix at least once a year and after any major life event keeps your portfolio aligned with your actual circumstances rather than assumptions you made years earlier.

Building a Tax-Efficient Plan

Tax considerations are another critical component of retirement asset allocation. Different types of investment accounts are taxed differently, and understanding how to manage withdrawals for tax efficiency can help extend the longevity of retirement savings. 

Qualified accounts, such as traditional IRAs and 401(k)s, are taxed as ordinary income when withdrawals are made, whereas Roth IRAs and Roth 401(k)s offer tax-free withdrawals. Taxable brokerage accounts may also have favorable capital gains treatment.

A tax-efficient withdrawal strategy can involve drawing from taxable accounts first, allowing tax-advantaged accounts to continue growing. The order in which assets are sold can have a significant impact on overall tax liability. Additionally, retirees can consider Roth conversions in low-income years to reduce future required minimum distributions (RMDs) and potentially lower their tax burden over time.

Bottom Line

As you transition into retirement, knowing how to set your asset allocation becomes crucial for financial security. The right mix of stocks, bonds, and other investments can help protect your nest egg while providing the growth needed to sustain your lifestyle through retirement years. Remember that your allocation should evolve as you age, typically shifting toward more conservative investments while still maintaining some growth potential to combat inflation. Consider working with a financial advisor who can help tailor your portfolio to your specific needs, risk tolerance and retirement timeline.

Retirement Planning Tips

• Building an appropriate asset allocation and creating a retirement income plan can be complicated. Luckily a financial advisor can potentially help with both. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• In addition to your pension or retirement plan, here are five additional ways to get guaranteed retirement income.

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