You can’t guarantee that retirement will be smooth sailing, but you can be prepared to weather the challenges.
Retirement generally has surprises — some welcome and others you could do without. The least welcome are often the financial setbacks that interfere with your plans or your peace of mind. And while there is no way you can prevent an economic downturn or a spurt of inflation, there are things you can do now that may help insulate you from their most serious consequences.
The first step is analyzing the sources of retirement income you can anticipate, how much you can expect these sources to provide, and the changes — if any — you should consider making in the way you’re investing and managing your money.
As you transition from work to retirement, you may want to rethink your approach to asset allocation, or the percentages of your investment portfolio you assign to different asset classes. Since your taxable and tax-deferred investments are held in different accounts, you may — like many people — have been allocating them separately, rather than as components of a single portfolio. That may work fine. But rather than owning several assets classes in each type of account to help manage risk, you may want to concentrate certain types of investments in your taxable accounts and other types in your tax-deferred or tax-free Roth accounts.
So, for example, instead of owning equity, debt, and some alternative investments in both retirement and nonretirement accounts, you may want to emphasize equities in one and bonds and cash in another. Among the factors you’ll want to consider in making these choices are how any earnings will be taxed, whether withdrawals are required, and the rates at which assets have the potential to grow.
You’re probably familiar with the value of having savings that could cover six months or so of expenses in an emergency. But the role of an emergency fund takes on a different dimension in retirement.
When you tapped your emergency fund while you were working, you expected to be well enough to return to your job or have minimal delay in finding a new one. But when much of your retirement income depends on investment returns, as it does if it comes from a 401(k) or similar account and personal investments, a repeat of the 2008 freefall in the financial markets could mean a significant shortfall.
To provide the protection you need, a retirement emergency fund should hold two years worth of living expenses, and perhaps more, in a combination of liquid accounts that are essentially free of market risk, such as certificates of deposit (CDs) and Treasury bills and short-term notes.
As you invest, stocks and stock funds may still dominate your portfolio, especially if you have a fixed-income pension. You may gravitate toward dividend-paying stocks and the funds that invest in them, preferred stock, and perhaps a small percentage in income-focused investments including REITs and certain limited partnerships — provided you are comfortable committing capital to an essentially illiquid investment for a period of time.
Investment income differs from fixed-income pension income in at least one important way: its potential to outpace the rate of inflation over an extended period. Even pensions with cost of living adjustments (COLAs) rarely increase enough to maintain buying power. But if your investment rate of return is sufficiently greater than the rate of inflation plus the rate at which you withdraw from your accounts, your assets can continue to grow in value at the same time they are providing a source of income.
Managing Retirement Income. Complete Guide by Inna Rosputnia
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