I recently chatted with a retired couple who were looking for a second opinion about their portfolio鈥檚 . The key question: Is 65% in stocks too high for someone in their situation? Here, I鈥檒l walk through some ideas about how to think through these issues.
First, cover the basics
Jot down what your spending looks like in a typical month, including costs for housing, food, medical care, insurance, clothing, charitable donations, and taxes. Then you can add in discretionary spending, such as travel, entertainment, major purchases, and the like.
If you鈥檙e working with a , he or she should be able to use this data to estimate your lifetime spending needs. If you鈥檙e managing your own assets, you can do a rough calculation by reverse engineering the 4% rule: Multiply your planned annual spending by the inverse of the withdrawal percentage; for example, someone who plans to spend $50,000 per year would need a portfolio of at least $1.4 million ($50,000 times 28.6, which is the inverse of 3.5%).
Next, it鈥檚 time to think about asset allocation for these core assets.
Scenario 1: Legacy focus
If you want to prioritize leaving assets (bequests) to or family members, you might be comfortable with a higher equity allocation, which should allow for continued growth while the assets are still in your portfolio.
Scenario 2: Capital preservation focus
Investors who aren鈥檛 as focused on asset growth for eventual bequests to charity or family members might be more comfortable prioritizing safety instead, and can tilt their 鈥渆xtra鈥� portfolio towards bonds.
Of course, these two scenarios are just a starting point. A couple in this situation might end up deciding on a portfolio allocation somewhere in between, or decide to carve out additional buckets, such as a separate bucket for charitable donations during their lifetime or another bucket for 鈥渇un money鈥� to enjoy the fruits of a lifetime of work and saving.
Other considerations
Even for investors comfortable with a higher equity allocation, it鈥檚 prudent to reduce exposure to individual stocks if they鈥檙e significantly overvalued or consume a large percentage of the portfolio (5% or more is a rough guideline).
It鈥檚 also worth considering whether each spouse has the same level of risk tolerance and comfort with investing. Think about how a surviving spouse might handle remaining assets and make sure the portfolio鈥檚 asset mix is something both members of the couple are comfortable with for the long term.
Conclusion
At the end of the day, there鈥檚 no 鈥渞ight鈥� answer to creating an asset-allocation mix. It all comes down to an individual鈥檚 level of risk tolerance, portfolio size, and anticipated spending needs. But investors who have enough assets to cover their planned spending during retirement鈥攁nd then some鈥攈ave more flexibility to create a customized asset mix that reflects their goals and priorities.
Amy Arnott Of Morningstar, The Associated Press
