How Much of My IRA Should I Have in Stocks?
In years gone by, an individual simply subtracted his age from 100 to find the percentage of stocks to hold in his portfolio. It was an answer easily digested by someone in, or near retirement, and an answer that worked fairly well. But a lot has changed and easy answers aren’t always the right answer.
What changed? Today’s investors face an entirely different landscape as they approach their non-working stage of life: traditional pensions are no longer a common source of steady income, interest rates have fallen from double-digits in 1980 to historic lows, today, and stock market events, such as the Tech Bubble and the Financial Crisis have left a generation fearful for the next event. Yet, what hasn’t changed, is a retirees’s need to generate income, today, while battling inflation, tomorrow.
Redefining Risk During a working career, the focus is on building a retirement nest egg. The question is “Will I have enough?” When the paychecks were still coming, investment risk was framed as the ability to tolerate portfolio ups and downs – some individuals could tolerate a little risk, while others could tolerate a lot. But in retirement, the focus is on depleting, not building, that nest egg, and the question shifts to “Will my money last?” Risk tolerance suddenly flips to risk avoidance. What many fail to acknowledge is that risk is multifaceted, encompassing market risk, interest rate risk, and inflation risk. Risks can never be avoided, they must always be managed. The main purpose of investing in stocks (market risk) is to grow today’s portfolio to battle higher prices (inflation risk) tomorrow. Traditional income sources, such as bonds, expose investors to all three risks, listed above.
Don’t focus on Asset Allocation Investors in retirement need to reframe their idea of Asset Allocation, and think instead about Income Allocation. The first question can’t be “How much do I allocate to stocks?” The first (and two-part) question needs to be “How much income do I need, and from where will it come?” While asset allocation is about the mix of stocks and bonds, income allocation is about Social Security, pensions, part-time work, dividends and investment withdrawals. If your income allocation is sufficient to ensure a lifetime of inflation-adjusted income, it almost doesn’t matter how much you allocate to stocks. So, how much of your IRA should you allocate to stocks? There is no simple answer. The answer depends on the income you need, the risk you can tolerate, and the legacy you want to leave behind.