Go ahead and start planning for your retirement and NO, we don’t mean like you have been doing so. We really, really mean it. If you are still unsure what to do about it, here are a few winning AARP tips:
Make Sure Your Portfolio Is Sufficiently Diversified
About 25% of Americans say they do not have an opinion on whether their investments are diversified, according to a 2019 CNBC-Morning Consult survey of 2,200 adults throughout the U.S. The same survey also revealed that more than four in 10 Americans do not actively monitor their portfolios to make sure their investments are diversified, while only about 34% say they do review their investments for diversification.
The modern concept of diversification is often ascribed to the work of U.S. economist Harry Markowitz. In 1952, he penned an article for the Journal of Finance entitled “Portfolio Selection,” in which he argued that investment risks and rewards are equally important for portfolio design. Markowitz was later awarded the Nobel Prize for his development of the Modern Portfolio Theory.
Common asset classes – like cash deposits, bonds and equities – inherently possess potential risks and rewards for investors. Portfolio diversification often includes more than just one type of investment to help investors buffer downside risks and potentially reap the rewards from multiple investment sources as they manifest over time.
“Diversification is beneficial provided that returns aren’t perfectly correlated,” says Michelle Cluver, chartered financial analyst and portfolio strategist at Global X ETFs. “The optimal situation is to combine market areas that respond differently. For example, equities and fixed income traditionally have a low correlation, as fixed income can provide a cushion during periods of economic stress where equities are likely to face headwinds.”
She adds that after diversifying across asset classes, it’s important to diversify within each asset class. Diversify geographic, sector and industry exposures within equities, and vary the duration, segment and credit positioning within fixed income.
Aim for Tax Efficiency in Your Portfolio
Beyond portfolio diversification, the way you allocate investments across different types of investment accounts can also improve your outcomes over time. This approach is often referred to as a tax-smart strategy and allocates investments such as municipal bonds and exchange-traded funds, or ETFs, to taxable accounts and more active investment strategies, such as multi-asset income funds, to tax-deferred accounts (e.g., an IRA).
Consider Annuities for Income Protection
Research from the Life Insurance Marketing and Research Association revealed that 70% of workers believe an in-plan guarantee (or an income annuity of some kind) should be an option in their workplace retirement plans, like 401(k) and 403(b) retirement plans.
Longevity is a key planning priority. In fact, the Social Security Administration estimates that men and women will live another nearly 17 and 20 years, respectively, after they reach age 65. Low-cost annuities (yes, they do exist) can be an effective strategy to mitigate longevity risk for some retirement investors.
Mitigate Sequence-of-Return Risk
“It’s important to manage risks from both long- and short-term perspectives. In the early years, participants are exposed to market and event risk, and a high allocation to diversified risk assets allows for both higher growth potential and the ability to dampen volatility in shorter time periods. As people come closer to retirement, interest rate risk, longevity risk, and market and event risk become more prevalent as cash flow volatility increases,” says Dan Oldroyd, managing director and the head of target-date strategies for Multi-Asset Solutions at J.P. Morgan.
If the equities market takes a double-digit dip shortly after an investor retires, it can complicate their withdrawal strategy. This quagmire, the prospect of having to sell more shares of a stock or equities fund to generate the level of income needed, is often characterized as the sequence-of-return risk. Investors can buffer this risk with a targeted allocation to less volatile investments, like cash equivalents and short-term bonds, to cover one to two years’ worth of cash-flow needs.
Hold Cash Reserves for Emergencies and Short-Term Goals
Less than half of Americans have enough emergency savings on hand to cover three months’ worth of nondiscretionary expenses, according to data from a 2023 Bankrate emergency savings report. Some good rules of thumb are for dual earners to maintain enough savings in bank deposits or liquid money-market funds to cover three months’ worth of fixed expenses; the metric is six months’ worth of expenditures for single earners.
What about short-term goals, like a down payment for a new home? Generally, a short-term goal includes an expense that could occur within the next 60 months. So, it’s a good practice to keep designated savings for short-term goals in liquid, stable deposits as well.
Consider Hiring a Financial Planner
Are you comfortable with your current strategies for retirement? How do you monitor whether you are on track with your financial goals? If you are open to a collaborative approach for these types of questions, consider engaging an objective financial planner, such as a certified financial planner, or CFP, practitioner.
A 2021 Fidelity Investor Insights Study cites data that show investors’ annual outcomes have been enhanced by approximately 1.5% to 4% over time by working closely with a financial advisor. These positive outcomes were generated by intentional strategies, like a personalized investment plan, tax-smart withdrawals, Roth IRA conversions and estate planning.
Hold Enough Equities in Your Portfolio
To help keep up with inflation and stay on track with the growth potential you may need through retirement, lean into the “Popeyes” within your portfolio. Much like the spinach consumed by the hardy cartoon character, innovation in equities combats inflation and delivers the needed returns over time. According to research from Hartford Funds, from March 1973 to December 2020, U.S equities exceeded the rates of inflation 76% of the time when inflation was above 3% and on a downward trend.
“Equity level is an important decision when planning for retirement,” says Oldroyd. “We focus on replacing income, leveraging Chase data representing half of America’s households to understand the needs of retirees. This motivates our 40% equity allocation at retirement, to ensure we can support retiree spending for their entire retirement journey.”
Manage Your Estate
Income in respect of a decedent, or IRD, includes any income someone would have received if death had not occurred, and was not included in their final tax return. Some common examples of IRD are uncollected wages, distributions from a deferred compensation plan, bank-deposit interest, accounts receivable paid to a decedent’s small business (cash basis only), exercised stock options and taxable distributions from a retirement account.
If the IRD and other assets owned by a decedent are not adequately accounted for in an estate plan, things can get complicated, or even burdensome, for surviving loved ones. As a preventative measure, check on the beneficiary designations for your retirement accounts, and review the “big three” documents: will, durable power of attorney and advance medical directive. A qualified estate attorney can make sure these documents reflect your intentions and are up-to-date with prevailing state laws.
Takeaway
These 10 strategies are not exhaustive, but they are intended to establish a framework for a deeper level of customization and confidence in a retirement plan. They also reinforce the many aspects of retirement planning that are within your control as an active participant in a workplace retirement plan as well as any outside investments. It’s important to diversify, manage sequence-of-return risk and keep enough equities in your portfolio to battle inflation and support your individual retirement needs.
