How to Build the Right Mix of Investments in Retirement

We show you how to allocate your investments among stocks, bonds and cash as you approach, enter and live in retirement.

Happy Couple And Mature Consultant Discussing Together
(Image credit: AndreyPopov)

Before Tim O’Brien retired in 2014 after a 30-year military career, he took a hard look at his investment portfolio and decided it was too aggressive. So O’Brien started trimming his allotment to stocks. When he was done, he had just 60% of his retirement savings in stocks, compared with 80% before the shift. Though he figured he’d earn less on his investments over the long term, it was a small price to pay for a more stable portfolio when he expected to be tapping his savings.

But O’Brien, 54, found retirement dull and has already returned to work, as a project manager for a health care firm. Although he’s in no rush, he expects to boost his stock allocation over the next year to reflect his changed circumstances. He says that after he and his wife, Fern, 56, retire in six or seven years (presumably for good this time), they’ll go through the process once more. After all, your investments ought to suit your life, so major changes suggest significant shifts in strategy. After the portfolio revamping, “Fern was concerned that our investments weren’t earning as much,” says Tim. “I told her that’s okay—we’re not risking as much, either.”

Taking a page from O’Brien’s playbook and reviewing—and possibly revising—your portfolio before, at and during retirement is a wise move. “This is where the rubber meets the road,” says Judith Ward, senior financial planner with mutual fund giant T. Rowe Price. “As you get into your fifties, you need to start looking at where you are and start ramping up your retirement and investing planning.”

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Few questions are as vexing as how best to allocate your assets when you’re in or near retirement—particularly in light of today’s excruciatingly low interest rates. Theoretically, you would want to start ratcheting down risk as much as 10 years before your anticipated retirement date and keep cutting risk as you age to reflect a shorter time horizon, which gives you less time to recover from investment losses.

But cutting exposure to stocks too aggressively could hinder the growth of your nest egg, potentially leaving you with less than you need. “The few years before you retire is when you need the growth the most, but it’s also when you have the most to lose if there’s a bear market,” says Michael Kitces, partner at Pinnacle Advisory Group, a money management firm in Columbia, Md. “A low-rate environment makes this particularly tough.”

To complicate matters, every investor is likely to have a different capacity and tolerance for risk. What’s the difference between risk capacity and risk tolerance? Risk capacity is a practical measure, dictated by assets, sources of retirement income and spending. If there’s little or no gap between what you expect to spend and the amount you expect to receive from pensions and Social Security, for instance, your risk capacity is high. If the gap is wide, your capacity to withstand investment losses—and thus your ability to take investment risk—is low. Risk tolerance is psychological, reflecting your emotional ability to handle losses without flinching or selling in a panic. When allocating retirement assets, investors need to keep an eye on both.

Both O’Briens have defined-benefit pensions. Fern is a teacher, covered by the California State Teachers Retirement System. Tim, a former Air Force colonel, has a military pension. Tim expects the pensions to cover 80% of their regular spending in retirement. That gives them plenty of risk capacity. But because they still have a daughter in college and are unsure whether they’ll need to kick in more for college bills than they planned, their risk tolerance is comparatively low. The moderate allocation to stocks that they chose on the eve of Tim’s early retirement reflects this push-pull. Investors with both the capacity and tolerance for risk might invest more aggressively; those who could be shattered by market losses might choose a more conservative approach.

Reasonable guidelines. In other words, no single formula is perfect for everyone who is near or in retirement, but there are certainly sensible allocation ranges. Target-date retirement funds provide a glimpse at how some savvy investors shift their allocations over time. Vanguard Target Retirement 2025 Fund (symbol VTTVX (opens in new tab)), which is designed for investors who are about 10 years from retirement, recently had 66% of its assets in domestic and foreign stocks. Meanwhile, Target Retirement 2020 (VTWNX (opens in new tab)), geared for customers five years from retirement, had 58% in stocks. And Target Retirement 2015 (VTXVX (opens in new tab)), aimed at those who retired recently or will be retiring soon, had 48% in stocks. The rest of the funds’ assets are in bonds. T. Rowe Price takes a more aggressive approach. At last report, T. Rowe Price Retirement 2025 Fund (TRRHX (opens in new tab)) had 70% of its assets in stocks, while Price Retirement 2015 (TRRGX (opens in new tab)) had 52% in stocks.

Assuming you have a 401(k) plan at work, a good way to start making this shift is to change your investment elections. If you had been directing most of your contributions into stock funds, funnel new money into bond funds. Every six or 12 months, total up all of your long-term investments—in your 401(k), IRAs and taxable accounts—and see how much you have in stocks, bonds and cash-type investments. If you plan to retire at age 66 or 67, reduce the stock portion of your overall portfolio to 50% to 60% of assets by your last day of work. If you retire early, as the O’Briens did, your stock allocation might be a little higher; if you retire later, a bit lower.

After you retire, you should gradually make your portfolio more conservative to reflect the fact that you have less time to wait out downturns and are likely to be using a greater percentage of your investments to meet expenses. (After all, if you earn less on your investments than you spend, each passing year of spending eats up a slightly larger percentage of the total account.) Ten years into retirement, Morningstar recommends that conservative investors have just 35% of their money in stocks and the rest in bonds. Note that Vanguard Target Retirement Income Fund (VTINX (opens in new tab)), aimed at those who are 10 years into retirement, has just 31% of its assets in stocks, but T. Rowe Price Retirement 2005 (TRPFX (opens in new tab)), for those who retired in 2005, has 37% of its assets in stocks.

Of course, a good investment mix should be widely diversified among big and small companies and between U.S. and foreign firms. Your bond holdings should be diversified, too. If you want your investments to generate generous cash income, you’ll have to look far beyond money market funds and CDs (see 41 Ways to Earn Up to 11% on Your Money). And as retirement looms, you will want to build up your cash holdings so that you won’t have to sell investments to finance spending when the stock market is down.

Kathy Kristof
Contributing Editor, Kiplinger's Personal Finance
Kristof, editor of (opens in new tab), is an award-winning financial journalist, who writes regularly for Kiplinger's Personal Finance and CBS MoneyWatch. She's the author of Investing 101, Taming the Tuition Tiger and Kathy Kristof's Complete Book of Dollars and Sense. But perhaps her biggest claim to fame is that she was once a Jeopardy question: Kathy Kristof replaced what famous personal finance columnist, who died in 1991? Answer: Sylvia Porter.