New retirement investing idea: It’s safer to keep more in stocks
We all know that the older we get, the more of our money should be kept safe. To achieve that, we gradually lower the percentage of savings we hold in stocks and increase our commitment to bonds. That’s classic, standard investment advice.
But I’m starting to think that’s wrong. Quality bonds and certificates of deposit aren’t paying much these days. The nore we depend on interest-rate investments, the more likely it is that we might run out of money in our older age. It might be safer to gradually hold more money in stocks, rather than less, after we retired.
When I first heard that idea, I said, “Nuts. High risk.” But new research by Michael Kitces, director of research for the Pinnacle Advisory Group in Columbus, Md., changed my mind. It turns out to be a low-risk approach that could make your retirement savings last longer and, potentially, leave more for heirs. I’m now looking at retirement investing in a whole new way.
Think of it as a “three-bucket” strategy, Kitces says.
In one bucket you hold cash to help cover your expenses for the current year. That’s grocery money. Keep enough pay any bills not already covered by other income, such as Social Security, pension or part-time work.
In the second bucket, you own short- and intermediate-term bond mutual funds, with dividends reinvested. You gradually add to your bonds during your pre-retirement and immediate post-retirement years. By age 65 or so, these first two buckets might hold 70 percent of your retirement investments. Every year, you take money from the bond bucket to replenish your cash. With a proper withdrawal strategy, discussed below, the money in your bond funds could last 15 years or longer.
The remaining 30 percent of your money goes into a third bucket, invested in mutual funds that own U.S. and international stocks. All dividends are reinvested. You don’t expect to touch these funds for 10 to 15 years.
As time passes and you sell bond shares to pay your expenses, the amount of money in your bond bucket shrinks. As a result, the percentage of your savings that you hold in stocks will gradually rise. There’s no reason to sell stocks in bear markets because your bond funds are covering your living expenses. In fact, your fund’s dividends will be buying you more stocks cheap. By the time your bond bucket runs low, your bucket of stocks will have grown in value, maybe by a lot. That’s money for your later years.
When withdrawing cash from your bond funds, follow the 4 percent rule for making money last for life. Start with an amount equal to 4 percent of all your savings (counting both stocks and bonds) and raise it by the inflation rate in each subsequent year. For example, say you have $100,000 — $70,000 in bonds, $30,000 in stocks. Your first withdrawal would be $4,000, and would rise from there. (If you take more than 4 percent, your savings might run out too soon.)
What makes this three-bucket strategy low risk? First, your bonds secure your grocery money for at least 15 years. Second, if the market crashes when you first retire, you have only a modest amount in stocks and can afford to wait for a recovery (people who sold after the 2008 crash came to regret it). Third, owning growth investments makes it less likely that your money will run out.
When you think about it, Kitces’s approach echoes the rules of thumb that younger investors live by: Keep short-term money safe and invest long-term money for growth. Think of your first 15 years of retirement as “short-term, safe.” Let the rest of your money grow, to pay for the later years of your life.