This article will include all the important concepts about investment portfolio and the best ways to help you manage your retirement investment portfolio. For most people, a retirement portfolio should be the whole or majority part of their investment portfolio, which will be our focus. We have included the solutions for both pre-retirement and retirees, which could be different in some ways.
Part 1: Some general concepts
An investment portfolio is a basket of assets, and the purpose is to generate returns and increase wealth over a long period of time according to your risk tolerance and financial goals.
There are two primary tasks: portfolio setup and asset allocation; portfolio management and rebalancing.
There are 3 common types of investments: stocks, bonds, alternative investments (including real estate, gold, cryptocurrencies, etc.).
We have some general asset allocation recommendations for any portfolio setup. You can make adjustments according to your risk tolerance, expertise, and financial goals.
Alternative investments should be within 25% of all investments. Stocks and bonds should be the primary components for your investment portfolio.
Speculative or short-term investments should be within 5% of all investments. You should be prepared to lose all the money invested for speculations.
The most famous value investor Warren Buffett suggests that, excluding alternative investments, all other capital can be allocated to 90% low cost S&P 500 tracker ETF (VOO) and 10% short-term government bonds (not bond ETFs, which could be with negative returns while the actual bonds are always with positive returns). This portfolio requires investment over a very long period of time, and is usually considered aggressive for wealth accumulation.
You can setup automatic contribution (with dividend automatically reinvested) from your bank, so that extra savings can be contributed to your investment account on a monthly basis. The long-term return could well exceed your expectations.
We also have some general portfolio management and rebalancing recommendations for any portfolio setup. You can make adjustments according to your risk tolerance, expertise, and financial goals.
Annual rebalancing: At each year end, you may review the current proportions of all the investments, and reallocate so that it comes back to the original designed proportions. For example, a 80/20 stock and bond portfolio can become 70/30 at year-end, and you can rebalance back to 80/20.
Crash investing: It is best that you can avoid a stock market crash or real estate market crash by selling some of your assets. But most importantly, you need to invest after the crash, where there could be many wealth generating opportunities. Crash means over 50% drawdown for an asset class.
Part 2: Retirement portfolio setup and management (pre-retirement)
One of the main goals of retirement planning is to set up a portfolio that will meet your income needs when you retire.
On the one hand, a retirement portfolio must generate enough long-term growth to overcome the effects of inflation, which erodes the purchasing power of your money over time.
However, some people are hesitant to invest too heavily in stocks, which are historically more volatile than bonds or cash, at least in the short run.
As a result, a common strategy is to invest in a mix of assets designed to seek a certain return at a level of risk you deem acceptable. This is also referred to as a risk-adjusted return (Daily Capital).
What is a retirement portfolio?
A retirement portfolio consists of all the financial assets you own to support your life when you retire.
Think of an investment portfolio as a basket that holds all of the investments you have in your various retirement and non-retirement (taxable) accounts. Ideally, your portfolio grows with you and provides the income you need to live out your post-work years in comfort (Investopedia).
Your account might hold different forms of assets like stocks, bonds, exchange-traded funds (ETFs), mutual funds, commodities, futures, options, and even real estate.
Together, these assets form your investment portfolio.
What are the benefits of a retirement portfolio?
A retirement portfolio has the potential to support your Social Security benefits and make you a reliable source of income.
Because a retirement portfolio is diversified, it can protect you from market volatility by balancing different income classes. If one asset class drops in value, others can pick up the slack.
When should I start a retirement portfolio?
You should start a retirement portfolio earlier enough to accumulate as high as possible income for your retirement age.
Constructing a retirement portfolio
A retirement portfolio needs to produce reliable cash flows that last the rest of your life regardless of the variety of market conditions that occur over your retirement years. Rather than controlling the volatility of the account values, you need to manage the volatility of the income stream so it is as consistent as possible.
In other words, you need a retirement portfolio that remains standing under all conditions. There are many ways you can construct such portfolios.
The question is, how can you set up a retirement portfolio?
Start by focusing on these areas:
Estimate your desired retirement income:
The amount of money you desire for your retirement age will have an impact on how much your portfolio should be.
Consider how much you are spending today:
Which among these expenses will go away for some reason and which of these expenses will increase along the way?
Also, consider income sources outside of your retirement portfolio that will help meet your retirement expenses, such as pensions, Social Security benefits, for part-time work.
This exercise should give you an idea of how much income your portfolio will need to generate.
If you need to know how much money is needed for retirement, you may check our Wealth Status Self-evaluation.
Then, it's time to get started on how you are going to achieve them.
1. Determine your time horizon.
This is all about at what age you desire to retire.
You should know how many years you have to save and grow your portfolio, as well as how much you should be saving in those working years.
Second, what is your life expectancy? Said another way, how many years do you anticipate living after you retire?
When you answer these questions, your portfolio needs to be invested in such a manner that will help you in your retirement goals.
2. Assess your risk tolerance.
As you are planning to set up your retirement portfolio, make sure that you put into consideration your ability to take risks.
You might be comfortable with a high percentage of riskier investments like stocks in your retirement portfolio.
But if stock market volatility makes you uneasy and makes you uncomfortable or have sleepless nights, you might consider a low-risk investment in your retirement portfolio like bonds and cash.
3. Look around you.
One piece of advice for beginning investors is to buy stock in companies you already know and like.
You can put your investment in companies that you are already familiar with.
Investing in small-cap and mid-cap companies not widely known but you're familiar with is potentially a way to spot great companies while they're still considered growth stocks.
4. Do your research
It's not enough to know or even like a company; you need to have some confidence that the value of the company is increasing over time. To find out what you need to know, look at the company's financial documents.
Reading those documents will allow you to know how this company is performing.
And then make an informed decision based on your findings.
5. Sales growth:
Are both companies expanding their sales year over year? Which company is doing so faster? Same-store sales growth is a useful metric because it eliminates many variables to more clearly indicate how well a retail company is performing.
Profitability: Are both companies profitable? Which company is more profitable on a per-share basis? Earnings per share is a useful metric to help you understand and compare the profitability of similar companies.
6. Guarantee the outcome
If you want something that is 100% guaranteed, give up the idea of a traditional portfolio. Instead use government bonds and annuity products (immediate annuities, fixed annuities, equity index annuities, variable annuities with income riders, and longevity insurance or a QLAC – which is a form of a deferred immediate annuity.)
Managing your retirement portfolio
Retirement portfolio management deals with ways by which you can make sure that your income meets your needs when you retire.
This is all about setting up a retirement portfolio that's right for you based on your goals.
There is no easy answer to managing your retirement portfolio.
But there are some helpful concepts and general guidelines that can help you decide what is best for you, and also avoid serious mistakes that can jeopardize your financial wellbeing:
1. Active vs. Passive Management
Today, investors have more choices than ever before when we are talking about managing their money or investment.
One of these choices is active vs. passive portfolio management. Many planners exclusively recommend portfolios of index funds that are passively managed.
Others offer actively managed portfolios that may post returns that are superior to those of the broader markets—and with less volatility.
However, actively managed funds typically charge higher fees, which is important to consider since those fees can erode your investment returns over the years.
2. Robo-advisor
This process deals with a digital platform that allocates and manages a portfolio according to preset algorithms triggered by market activity.
Robo-advisors typically cost far less than human managers. Still, their inability to deviate from their programs may be disadvantageous in some cases.
And the trading patterns they use are generally less sophisticated than those employed by their human counterparts.
This might not be the best choice for you if you need advanced services like estate planning, complicated tax management, trust fund administration, or retirement planning.
Bottom line: do thorough findings about the company you want to put your retirement money on.
And make informed decisions based on the outcomes of your research.
Also, your retirement goals should be aligned with your retirement portfolio.
Part 3: Retirement portfolio setup and management (for retirees)
What should a retiree portfolio look like?
Finally you are retired. So what's next?
You need budgeting, insurance planning, and an investment portfolio designed specifically for retirement life. You may also consider downsize your home or move to a new city or even a new country for lower cost of living.
The conservative allocation is composed of 15% large-cap stocks (ETFs), 5% international stocks (ETFs), 50% bonds, and 30% cash investments.
The moderately conservative allocation is 25% large-cap stocks (ETFs), 5% small-cap stocks (ETFs), 10% international stocks (ETFs), 50% bonds, and 10% cash investments.
The moderate allocation is 35% large-cap stocks (ETFs), 10% small-cap stocks (ETFs), 15% international stocks (ETFs), 35% bonds, and 5% cash investments.
Experienced investors can hand pick 10 - 15 good stocks, but most people can just pick the corresponding ETFs. Please note that past performance is no guarantee of future results.
Note: large-cap and small-cap stocks (ETFs) primarily refer to US stocks (ETFs) and the stocks from your country.
How to manage your investment portfolio when you retired?
1. Don't make fear-driven or emotional decisions.
As a retiree, you should not indulge in fear during the market down or uncertainty or doubt during the market downtown.
A common example is panic selling during a crash to preserve capital by fleeing into safer money market instruments.
This ensures that investors "buy high and sell low," which destroys portfolio value and can severely harm your retired investment portfolio.
Bill Cannon, director of retirement plan consulting at Wealth Enhancement Group, suggests mitigating this by "filtering out the noise, and not reacting to the news cycle or geopolitical events."
A common suggestion echoed by many passive index investors might apply here: "stay the course." "Avoid short-term decisions for your long-term retirement income portfolio. You may regret them down the road," Cannon says.
2. Ensure your portfolio's asset allocation is sufficiently diversified.
As you retire, one of the best ways to manage your retirement investment portfolio is to avoid the risk of a single asset, stock, or sector in your retirement portfolio.
Professor Michael Collins of Endicott College in Beverly, Massachusetts, recommends "investing in a diversified mix of assets, including stocks, bonds, cash, and alternatives."
3. Hold a sufficient cash reserve.
Cash is the ultimate protection in a market downturn. While it loses value to inflation, during a bear market cash keeps its value.
Keeping a healthy allocation to cash in your retirement portfolio can help provide a reserve to draw on if other assets fall.
Jamie Ebersole, founder & CEO of Ebersole Financial in Wellesley Hills, Massachusetts, suggests "hold one to three years of living expenses in a cash runway."
"This helps avoid excess or surprise withdrawals that could be costly when your portfolio values are down," Ebersole says.
Investors can hold cash in their brokerage accounts, or purchase money market securities like Treasury bills, T-Bills, certificates of deposit, or CDs.
4. Review your spending and income plan at least once a year.
After years of working and saving, you likely started retirement with a plan for how much you can spend each year and which income sources you'll rely on for living expenses. If so, you're off to a great start. But what if your expenses or income fluctuate from year to year?
"Most retirees find they need to spend more or less than they planned at various points in their retirement," says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research. "Changes and unexpected events that require you to adjust your initial plan—like home repairs, uncovered medical costs, and market volatility—are inevitable. But knowing this and planning for it can help."
Rob recommends continuing to review your plan and portfolio annually, and any time you have a major life event, to ensure you're on track and adjust as needed. It may also help to talk with a financial planner, who can help you anticipate your long-term spending patterns, identify potential surprises, and put proactive strategies in place.
Part 4: Asset classes for hedging against inflation
Inflation occurs in market economies, but investors can plan for inflation by investing in asset classes that tend to outperform the market during inflationary climates.
1. Gold
Gold has often been considered a hedge against inflation. Many people have looked to gold as an "alternative currency", particularly in countries where the native currency is losing value.
2. Commodities
Commodities include grain, precious metals, electricity, oil, beef, orange juice, and natural gas, as well as foreign currencies, emissions, and certain other financial instruments.
3. Real Estate Income
Real estate income is income earned from renting out a property. Real estate works well with inflation. This is because, as inflation rises, so do property values, and so does the amount a landlord can charge for rent. This results in the landlord earning a higher rental income over time. This helps to keep pace with the rise in inflation. For this reason, real estate income is one of the best ways to hedge an investment portfolio against inflation.
4. Inflation Protected Securities
Some governments may offer inflation protected securities, which will increase in value in order to keep pace with inflation. There will usually be a limit of how much you can invest in.
The baseline for happy retirement | Blue Eden Project (blueeden-project.com)