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Retirement Planning > Retirement Investing

How to Find the Right Asset Allocation for Your Retiring Client

By Roger Wohlner

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What You Need to Know

  • Before determining a proper mix, clients need to assess the costs related to their preferred lifestyle.
  • A bucket strategy allows you to put money needed soon into lower-risk investments while earmarking other money for long-term growth.
  • The overall asset allocation will likely become more conservative as the client ages.

One of the key planning issues for clients nearing and then entering retirement is how to allocate assets. There is no single right answer. All clients’ circumstances and needs are specific to them. 

This includes sources of income, retirement spending and goals for their money. There are a number of target asset allocations for investors at various stages in retirement, and these can be helpful. But at the end of the day, clients are looking to advisors’ expertise to help them devise an asset allocation that fits their objectives, risk tolerance and time horizon. They also seek guidance to adjust this allocation as needed over time.

Here are several things to consider in determining the best mix for clients in this age range.

Retirement Spending Needs

A key factor in clients’ investment planning is their anticipated spending in retirement. What does their lifestyle look like and what will it cost each month? 

Spending needs might include:

  • Normal living expenses
  • Cost of travel or other activities in retirement
  • Health care costs, including Medicare
  • The cost of long-term care

Income Sources

Where clients derive their income can vary widely and will evolve over time with any single client. 

Sources of income might include:

  • Earnings from employment or self-employment
  • Social Security
  • Pensions
  • Income from investments
  • Payments from an annuity
  • Distributions from investment accounts
  • Distributions from retirement accounts, including RMDs

As clients transition from working into retirement, their primary source of income will migrate from full- or part-time employment to sources like Social Security, pensions and distributions for both taxable and retirement accounts. For those with a higher percentage of income from fixed sources, this should be factored into their asset allocation.

Age, Life Expectancy and Marital Status

A client who is younger generally has a longer life expectancy than older clients. However, not everyone at the same age has the same life expectancy. Does a client have any known health issues? Does family history point to a potentially longer life expectancy than normal?

For married clients, their portfolio needs to support the retirement of both spouses. If the spouses are relatively close in age, that potentially makes things a bit easier. If there is a significant age gap, this can point to a need to structure a portfolio allocation to help support what might be a considerably longer combined retirement.

Also embedded here is the need to ensure that clients’ investments keep up with inflation throughout retirement.

Risk Tolerance

At any age, a client’s risk tolerance is a key factor. We’ve all seen younger clients who may be more risk averse than we might think and older clients who are still feeling aggressive about their investments. This needs to be balanced between their personal risk tolerance and the level of portfolio growth they need to meet their future retirement income needs.

The Bucket Strategy

As far as allocating a retirement portfolio, advisors will want to think in terms of “buckets,” an approach espoused by Morningstar’s Christine Benz, among others.

Short-Term Needs

This bucket should generally consist of money that will be spent over the next year. This might include funds from taxable investment accounts as well as anticipated withdrawals from IRAs and other retirement accounts. As clients reach the age where RMDs commence, they will need to have the RMD money for the current year included in this portion of the allocation.

The money for short-term needs should be invested in a very low-risk and highly liquid fund like a money market fund. Clients should be able to access this money quickly with little or no downside risk attached.

Clients should also have a portion of their assets in an emergency fund. In retirement, this fund might include money for unexpected medical needs not covered by Medicare as well as unplanned expenditures for an activity or travel. It can also be used for emergencies like a major car repair, uncovered damage to their home from a major weather event and all of the other unexpected expenses such a fund is designed to cover.

The emergency fund should also be invested in a very safe, very liquid fashion. That means a money market fund, a high-interest savings account or similar type of account.

Intermediate-Term Needs

This can be defined as money needed within the next five years. This bucket can include a mix of cash and related holdings, high-quality short- to intermediate-term bonds and lower-risk stocks such as consistent dividend payers. Bond and CD ladders can be an appropriate investment here.

This portion of the allocation should be structured to allow for some growth in assets, but with a low to moderate risk profile.

Longer-Term Needs

The money that clients are unlikely to need within the next five years can be allocated to a high percentage of stocks and investments likely to offer longer-term growth.

Depending on a client’s age, this bucket may be more or less aggressive. Accumulating funds for future living expenses and RMDs is one purpose. For those planning to leave a legacy to family members, this bucket allows for growth in money targeted for this purpose as well.

Allocation by Account Type

The portion of the asset allocation geared for each of these purposes might vary by account type. For example, clients in their early years of retirement may focus more on withdrawals from taxable accounts if their income from other sources is still high to lessen their tax hit. Or, in some cases, younger clients might tap into IRAs as a primary source of cash in their “gap” years before claiming Social Security and commencing RMDs if their income and their taxes are lower during these years. 

Which accounts are being tapped and in what order is a factor to be considered in the asset allocation for those accounts. This is something that should be reviewed at least annually and taken into consideration to rebalance portfolios. 

Evolution Over Time

Much like the basic principle behind target date funds, clients’ retirement portfolios will likely see a reduced allocation to equities over time as they age. This is normal: Older clients do not have as much time for their portfolio to bounce back from a steep decline.

Roger Wohlner

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