As your retirement date approaches you realize that there will soon be a big, sudden change in your routine. The day before you retire, your alarm will go off at same time it has on every other work day, you’ll put on your work clothes and go off to do what you’ve been doing for a big chunk of your life. The very next day, you can sleep in as late as you want, stay in your pajamas all day, and spend your time however you like. It’s like flipping a big switch that makes a big change in your life, all at once.
But there’s at least one thing that shouldn’t suddenly change when you retire – your investments. Here’s why: ideally, you’ve been adjusting the way your money is invested, including your 401(k) and/or IRA savings for a few years before your retirement date was circled on the calendar. You’ve been gradually shifting your money to prepare for this change so that when the big day arrives, your investments are already where they should be.
In general, the goal for a retirement-ready portfolio is to reduce (not eliminate, but reduce) risk. In the investing world, that means “reduce volatility” so that when the stock market goes through some scary nose-dives, your overall portfolio takes just a small dip. This is important because you will most likely have to sell some of your investments to provide income throughout your retirement and you don’t want to be forced to sell at a big loss if you need income at a time when the market is down.
Of course, there is no perfect, one-size-fits-all plan for what to invest in as you approach and enter retirement. If you have a lot of savings, a paid-for house and other forms of wealth you can invest more aggressively than someone who has a modest amount of savings. As we get close to retiring, most people do shift more into lower-risk types of investments, but don’t think you need to drastically reduce your allocation to stocks that can generate a good return over the long run. Remember, your retirement could last for 20 years or more.
Remember the goal is not to choose just one type of investment. It is very important to spread your savings across different types of investments to diversify your risk. In fact, it’s the mix of investments (your “asset allocation”) that matters most. With that in mind, here are 10 types of investments to consider when you are thinking about retiring, to help ensure your investment portfolio is as ready for your retirement as you are.
- High quality, intermediate maturity corporate bonds or bond funds – Companies that issue bonds make coupon payments to investors, whether the stock market goes up or down. That’s why bonds are referred to as “fixed income” investments. Even when the market drops, high quality bonds issued by good companies keep making those payments; therefore bond prices don’t tend to fluctuate nearly as much as stock prices. Bonds won’t go up by much when the market is zooming, but they won’t go down by much either. Some people say bonds are boring, but in a good way.
Keep in mind that when interest rates in the economy go up, bond prices go down (and vice versa). The more years until a bond matures, the more its price is affected. Bonds with maturity dates in the 3-10 year range tend to offer reasonably attractive coupon payments without being as sensitive as longer maturity bonds. Those with very short maturities (two years or less) may not offer coupons that keep up with inflation.
- Stocks that pay good dividends – Dividends can generate some nice extra income. More importantly, stocks that have a track record of paying regular dividends that increase over time tend to mean the company is solid and will hold up well when markets turn volatile. Although you can buy individual stocks, there are mutual funds and ETFs that specialize in dividend-paying stocks. With this approach, you get a diversified mix of companies so you’re not too dependent on any individual stock.
- Municipal Bonds – If you are in a high tax bracket, especially if you live in a state with a high personal income tax rate, municipal bonds can be a good way of generating income without increasing what you owe at tax time. Like corporate bonds, the value of muni bonds depends mostly on what interest rates are doing, not on the stock market. Although defaults in the municipal bond market are quite rare, look for high quality bonds unless you are willing to take on additional risk in exchange for earning a higher yield.
- REITs – Real Estate Investment Trusts, or REITs, are funds that own real estate properties. Due to tax laws, REITs must distribute most of their income to investors every year, which means they tend to pay nice dividends. They also have the potential for capital appreciation. REITs often specialize in one type of property, such as office buildings, hotel properties, residential housing and others. REITs are a way to generate income and invest in real estate and receive income. In terms of risk, they have characteristics of both stocks and bonds, so they’re somewhere in between.
- Annuities – These are contracts guaranteed by an insurance company. Fixed annuities pay at a fixed rate, indexed annuities make payments based on a stock market index, and variable annuity payments come from returns on investments that you choose, with a guaranteed minimum. You pay the insurance company a lump sum upfront and the annuity pays you income regularly, over a specified period of time or for the rest of your life. That can provide real peace of mind in retirement. Annuities offer many options and there are fees involved, so ask a lot of questions before choosing one.
- U.S. Stock Market Index Fund – Yes, that’s right, even when you are close to, and then in retirement it is wise to invest some of your savings in the broad U.S. stock market. Even though the market can suffer some big downturns occasionally, as long as you have a good chunk of your savings in bonds you can ride out the storm. Over the long-run, investing in the stock market will provide better returns than just about anything else you can find. You can choose a fund that tracks the S&P 500 index, which represents the stocks of the largest U.S. corporations, or one that also includes mid-sized and small companies (a “total market” fund). It is easy to invest through an exchange-traded fund that charges extremely low fees (close to 0% in some cases).
The remaining tips are not about specific investments, but about what else you need to do with your finances to get ready for retirement. Start about a year before the actual day arrives.
- Calculate what your expenses are likely to be in retirement. Include everything you can think of – food, clothes, car maintenance, utilities, rent or mortgage payment if you do not own a home outright, entertainment, travel, and so on. Include healthcare costs, which will be more than you think.
- Determine your sources of income – that probably includes social security benefits, but you have to decide when to start claiming those benefits. There are many resources to help you evaluate this complex choice. If you are covered by a pension, find out what your payment will be and what options you might have. If you have a 401(k) or traditional IRA, figure out what your required minimum distribution will be if you start withdrawals as soon as you retire or postpone that until you are older.
- Figure out your medical coverage – If you plan to retire before you are eligible for Medicare, figure out how you will obtain health insurance. Think about dental and vision care insurance, too.
- Do what you can to stay healthy – you know what that involves. Eat right. Stay physically active. Get involved with hobbies or volunteering that you enjoy, and interact with others. Social isolation tends to have a negative effect on health.
You may wish to consult with a financial advisor to sort through all of these things long before your retirement party. Remember, even though you won’t be working anymore, your investments have to keep working for you.