Think about this analogy: When an airplane is preparing to land, it does not descend 30,000 feet in a matter of seconds. Rather, it happens gradually. The pilot adjusts to the landscape and weather conditions to secure a soft landing. In the years leading up to retirement, you should begin to treat your investment portfolio in a similar manner. Prepare ahead of time to protect your assets and adjust as dictated by market and economic conditions to help secure a soft landing in retirement.
Adjusting your portfolio means taking steps to "downshift" as retirement nears, reducing some of the risks that may exist in your asset mix. While you were focused on building wealth in the years you accrued savings for retirement, your focus should change as you approach the end of your working years. It's important to protect the wealth you've worked hard to build and position your portfolio to generate your retirement paycheck.
Dealing with unpredictability
Money invested in assets that vary in value, including stocks and bonds, are subject to periodic fluctuations. In prior years, you may have had time to ride out any market turbulence and over short short term losses once markets recovered. If you wait until retirement to adjust your portfolio, you may be surprised by an untimely market downturn. This unpredictability could result in a "hard landing" for your portfolio, leaving you with less money in retirement as compared to your plans.
For example, a couple with $ 1,000,000 saved for retirement may plan to withdraw $ 40,000 each year from that account, (assuming they withdrawal four percent of the principal value annually to sustain 25 years in retirement). If the money was all invested in stocks and the portfolio sustained a 25 percent decline just prior to retirement, the value would drop to $ 750,000, leaving the couple with $ 30,000 a year. By contrast, if they position the portfolio more strategically prior to retirement, they may have protected themselves, at least in part, from the market's downturn.
A gradual process
The process of shifting from accumulating wealth to an income-generation focus in your portfolio should happen over time. One approach is to gradually reduce your positions in assets that are subject to greater market volatility in the years leading up to retirement. For example, that may mean reducing your portfolio's exposure to stocks while increasing positions in fixed income investments.
However, not all your money needs to be moved out of stocks, even in retirement. Equities historically have offered more growth potential than many other types of investments. Given today's long life expectancies, you want to be prepared for the likelihood that living costs will be higher 20 or 30 years from the time you begin retirement. For this reason, stocks may still make sense for your situation. You may want to reduce your emphasis on investments that seek to maximize capital appreciation and emphasize stocks that tend to be less volatile and pay competitive dividends.
Other strategies may come into play too, such as annuities that provide lifetime income in retirement, or alternative investments that can diversify your portfolio. A financial advisor can help you determine a strategy that suits your specific circumstances as you prepare for a smooth retirement landing.