Crackerjack Greenback Prudent Advice for a Prosperous Future

November 28, 2008

What Asset Allocation Should I Use in Retirement?

Filed under: Investing,Retirement Planning — Paul Williams @ Crackerjack Greenback @ 4:00 am

       During retirement or any other time we’ll be withdrawing from our investments, it is important to make sure we have a portfolio that will beat inflation and allow us to reach our goals without taking on unnecessary risk. To determine what percentage of a portfolio should be in stocks during retirement, I researched safe withdrawal rates over different time periods using a variety of portfolios.

Dan's Retirement by Scubabix on Flickr       Using the Monte Carlo method, I found the optimal portfolios and safe withdrawal rates we should use over different withdrawal periods for a 90% probability of success. (This means you’d have a 90% chance of not running out of money before you die.) The safe withdrawal rate represents the percentage of your portfolio that you can withdraw at the beginning of the indicated time period. I assumed after the first year you would increase the dollar amount you withdrew by a 3.8% inflation rate every year. You can read more about safe withdrawal rates during retirement by clicking here.

       The chart below shows the time period (years left in retirement), safe withdrawal rate, successful portfolio range, and the recommended portfolio for someone with average risk tolerance. If you have a high risk tolerance, you could increase the percentage of your stocks to the upper end of the successful portfolio range. If you are risk averse, you could use a lower percentage of stocks as long as you do not go lower than the bottom of the successful portfolio range. If you don’t keep enough in stocks, you run the risk of not meeting your retirement goals because of inflation.

       Finally, it is very important to note that all of my simulations were completed using a diversified portfolio of index funds. You can read more about what a diversified portfolio looks like by clicking here.

Portfolios for a Successful Retirement

       My next project is looking at how much you need to save so you can even get to retirement. This is more complicated because you have people starting at different points in their lives with differing amounts of money already invested. I’m also looking at the savings rate in terms of your target retirement income instead of the income you’re earning right now. This makes more sense because saving 10% of your current income isn’t a very accurate rule of thumb for the majority of people. It doesn’t guarantee that you’ll have enough saved up to meet your retirement goals—your savings should be based on how much you’ll need in retirement and not how much you’re making now. If you have any questions, please feel free to leave them in the comments below!

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