You know you need to diversify your investments during retirement. But what exactly do you invest in? Investment advisors call your mix of investment choices your asset allocation (e.g., 50 percent stocks, 30 percent bonds, 20 percent cash assets). The key to asset allocation is choosing a mix that is (1) comfortable for your risk tolerance and (2) will meet your income needs during your retirement years.
Ideally you want a mix of all types of investments, but in varying proportions. You can compare the asset allocation process to cooking up a good batch of chili. Some of the ingredients are pretty standard, such as tomatoes, beans and onions. Some of the ingredients are pretty spicy, such as chili powder and cayenne peppers. You may not particularly enjoy (or even want) any one ingredient by itself. But when you mix them together in the proper portions, the outcome is a wonderful meal.
Your investment mix works the same way. Start with some relatively simple accounts, such as CDs, money market mutual funds and bond investments. These are lower-risk options. Then add some spicier choices that carry more risk, such as stocks, real estate, and foreign investments. The spicier investments will help grow your retirement accounts to keep up with inflation. Remember that risk and reward go hand in hand; less risk usually means lower return, and more risk usually means potentially higher returns. What is the recipe for a retirement portfolio? Here’s one sample version:
- CDs and money market mutual funds: Save up to five years of your living expenses that are not covered by Social Security and/or a pension (whatever that dollar amount happens to be) in safe places such as CDs and money market mutual funds.
- Bonds or bond mutual funds: Invest another five years (years five through 10) of living expenses in bonds or bond mutual funds. It’s a good idea to hold a mix of bonds from both corporations and the federal government. Treasury inflation-protected securities (TIPS) also may be a good choice; these government bonds are designed to grow with inflation.
- Longer-term spicier investments: Use your long-term money (years 11 and beyond) to invest in stocks, real estate and foreign investments. All of these spicy choices are easily available through mutual funds or exchange-traded funds (ETFs). These investments provide long-term growth for your retirement savings. Creating a broad mix of investments may smooth out the overall ups and downs you experience as an investor in the different markets. That emotional comfort can help you stick to your long-term plan as a retirement investor.