Back when interest rates were near 0%, the perfect retirement portfolio composition would have looked a whole lot different from the ideal mix of stocks and bonds today. Just a few short years ago, the term TINA was popular; it means There Is No Alternative but to buy equities.
The stock market, after all, had risen from a low of 666 in 2009 to over 3,000 and was clocking gains at a rapid clip. How could you deploy capital to anything but equities when the tide was rising so fast?
Today the opportunity cost is very different, though. Now 3-month treasuries pay 5.41%, meaning there is real competition for capital.
So, with interest rates up significantly over the past couple of years, how should you build the perfect retirement portfolio now?
What Is The Ideal Portfolio for Retirement?
The first thing to note is that the ideal portfolio for retirement changes over time. What’s appropriate for a 25 year old is very different from what works well for an 80% year old.
Conventionally, an appropriate retirement portfolio composition for a 25 year old would be an almost full allocation to equities with very few, if any, bonds.
By contrast, an 80+ year old should have a much greater exposure to bonds, north of 50% is recommended by Schwab, in conjunction with a 30% weighting to cash. Just 20% of the portfolio would be deemed appropriate to allocate to stocks.
Part of the assumption in this formula is that a retiree only has so much savings to last through their retirement days. Warren Buffett is 93 and breaks all these rules with a much greater allocation to equities than to treasuries or cash via his Berkshire Hathaway holding company.
But if you are a billionaire with all your assets in equities and they fall 90%, you still have $100 million leftover – more than enough to last a single retirement.
If you’re sitting on a million dollars in your portfolio, though, it’s best to be a lot more conservative than the Oracle of Omaha. You need the capital to ride through the final years of life, and all that it may throw out you from health hurdles to economic bumps in the road.
Schwab recommends that a typical retiree who is 60-69 divide their portfolio as follows with 60% stocks, 35% bonds and 5% cash.
A 70-79 year old, on the other hand, would boost their bond exposure to 50% and their cash to 10% while keeping 40% in stocks.
The 80+ year old would put half their wealth in bonds, 30% in cash and the remaining 20% in stocks.
Within the equity portfolio and the bond portfolio, what division of assets makes most sense?
The Perfect Stock Retirement Portfolio
Most financial advisors advocate for a diversified portfolio that encompasses a bunch of sectors and industries. Why bet the farm on technology stocks when a period from 2000-2002 can demolish the whole sector?
It simply doesn’t make sense to over-allocate to a single sector versus diversifying to many areas, such as consumer staples, energy, real estate, finance, utilities, healthcare, and aerospace.
With that said, be wary of gaining that exposure through actively managed mutual funds that often have higher expense ratios. Instead, consider passively managed exchange-traded funds that typically have lower fees.
Vanguard and Fidelity are exceptionally good at offering low-fee ETFs that offer retirees the exposure to various sectors but at the same don’t cost an arm and a leg.
If you want single stock exposure, that’s okay too. For most investors, though, it’s better to put all your eggs in a basket like the S&P 500 versus betting on your own preferred basket of stocks. Yes, you can outperform, but most don’t and there’s a good reason why.
The S&P 500 is a natural pruning basket that keeps the strongest stocks under its umbrella and eliminates the weaker holdings.
A self-selected portfolio, on the other hand, doesn’t have that natural pruning mechanism unless it is actively managed, and when it is the individual investor is susceptible to emotional swings as the market rollercoaster flows from highs to lows and back again.
What Is The 3% Rule For Retirement?
Once you have the perfect retirement portfolio constructed, and you are wondering whether it’s time to retire, do a quick check on the 3% rule for retirement, meaning can you withdraw 3% of your retirement annually without the nest-egg dropping in value. If so, you’re probably good to go to sail into the sunset and hang up your work gloves.
If you had a $60,000 income pre-retirement and are wondering whether you can retire while enjoying the same quality of life, then you would about $2,000,000 to retire based on the 3% rule for retirement.
You can quickly see that if you made $120,000 annually in income then you would need about $4,000,000 for retirement. In short, the more you need to sustain your quality of living, the larger the nest-egg you will need to build up before hanging up the boots, and calling it a day on your professional career.
Of course, there are ways around this, such as moving to a lower cost of living location, cutting expenses, and living more frugally generally. But retirees often make a key mistake at retirement thinking they will be able to cut costs, and neglect the fact that they now have much more time on their hands to be a consumer that spends.
Often, they find that their expenses rise in retirement as they start to travel more, eat out more, shop at malls frequently, and generally live a little more exotically than during their professional careers.
How Long Will $2 Million Last In Retirement?
The amount you have in your retirement portfolio is less important than how fast you spend your money. If you live life like someone rich and famous, preferring luxury restaurants, cars and trips, expect that $2 million to run out in retirement.
On the other hand if you spend no more than your earnings or interest on the $2 million minus taxes, you can theoretically sustain the $2 million forever.
The real key is to spend below your means. So, if you put your $2 million in a short-term bond earning 5% annually and pulled in $100,000 gross interest income, then after taxes, you likely cannot spend much more than that amount each year divided by 12 on a monthly basis.
For example, if you earned $5,000 after paying taxes, then your monthly expenditures should be limited to that ceiling. The good news is if you can do so, your $2 million could theoretically last forever.
#1 Stock For The Next 7 Days
When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.
Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.
See The #1 Stock Now >>The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.