Last week, I discussed the importance of making an asset allocation by age. In this post, I was explaining my “ideal” asset allocation according to your age. From the age of 51 until 65, I suggested investing in a balanced portfolio. This includes having 50% of your portfolio “at risk”. Why would you invest so much in equities when you are about to retire? There are some reasons why asset allocation for retirement should be relatively aggressive:
#1 You didn’t save enough when you were younger
The very first reason why your asset allocation for retirement should contain about 50% in stocks or index ETFs is because you may not have saved enough throughout your life. Therefore, low investment returns (such as 3-4%) won’t be enough to create a comfy nest egg. You will need to reach for a 5 to 6% investment return in order to retire early and happy! If you secure your asset allocation in bonds, you won’t be able to make it. This is why around 50% of your investments should be related to stocks in the decade before retiring.
#2 You will live longer than you think
There are 2 major mistakes people commit when they do their retirement planning:
a) They overestimate their investment return
b) They underestimate their life expectancy
While overestimating the investment returns (thinking you will be making 7-8% over the next 20 years) is an obvious mistake, many think they need money until they are 80 or 85… Well chances are that you will live until 90, 95…maybe even 100!
If you live until the age of 90, you need a much bigger investment portfolio than if you didn’t think you will see the sun after the age of 80. Here again, you will need to count on a higher investment yield to support your lifestyle. Modifying your asset allocation for retirement is about one of the only things you can do to make sure you have enough money.
#3 You won’t withdraw all your money in the first 5 years
Many people think that once they retire, they must invest in very secure investment vehicles. They are about to withdraw money from their investments and they fear any fluctuations. This is usually why they make the mistake of playing around with the asset allocation upon retirement. This is a very bad move!
When you look at it bluntly; you will be withdrawing money from your investments during the next 20 to 30 years. Therefore, there is no rush to change your asset allocation for a more conservative portfolio. A good asset allocation for retirement will be one that:
a) Will be flexible (so you can withdraw money on a steady basis)
b) Will protect your capital against inflation (so you don’t lose your buying power over time)
c) Will ensure you have enough money throughout your retirement! (so you don’t have to go back to work!)
Asset Allocation For Retirement – Sharing my model
I will go a little bit further with determining your asset allocation for your retirement by providing a model. Personally, I would start by creating a 45% fixed income, 55% equity portfolio with more aggressive investments in the fixed income portion if you are between 50 and 65;
25% of your investments in municipal bonds or mortgage funds
This will give you a solid base with little fluctuations. The fact that you are mixing mortgage funds with bonds will protect you from the risk of interest rate increases (as mortgage funds have shorter durations than bonds).
20% in a dividend ETF or stocks along with preferred shares or high yield bonds
This part of your asset allocation will still count as fixed income but will definitely run into some variations. If you are not too sure about dividend investing, I suggest you take a look at What is a Dividend, a reference for beginner dividend investors.
20% in US index ETFs
The US market is probably the most diversified and effective stock markets in the world. You can find very good companies that operate all over the world. While it hasn’t given much to its holders during the past 10 years (mostly because of the 2008 crisis), I think that the next 10 years will be different!
15% in Canadian index ETFs
Most investors are advised to invest a part of your account in commodities. While I don’t like commodities and would rather invest in companies, I am picking the Canadian market in my retirement asset allocation. Why? Because a great part of the Canadian economy is driven by different resources such as oil, gas, gold and paper. Buying the Canadian index is like buying commodities without taking all the speculative risk on your shoulders.
10% in International index ETFs
Since the beginning of this retirement asset allocation model, we have discussed nothing but North American investments. I think that having a part invested in the international market wouldn’t hurt either!
10% in Emerging Market ETFs
Finally, emerging markets should be part of any retirement asset allocation model. Why? Because you will probably live as a retiree for 20, 25 even 30 years. This is why you need some sources of growth over the long term. Emerging markets seem to be the perfect investment vehicle for that!
What do you think of my retirement asset allocation? Do you find it too aggressive? Would you be comfortable with such an asset allocation?