We all know — or think we know — that the older we get, the more our money should be kept safe. We gradually hold less in stocks and more in bonds.
But is your caution risking your future? Yes, says Michael Kitces, director of research for the Pinnacle Advisory Group in Columbia, Md. On average, we're living longer and not earning much on quality bonds and bank CDs, he says. If we huddle around investments that cannot grow, the risk rises that we'll run out of money.
What if we reversed the conventional rule and gradually held more money in stocks, rather than less, after we retired?
When I first heard that idea, I said, "Nuts. High risk." But as I read the new research, I changed my mind. It's actually an approach that could make your retirement savings last longer and, potentially, leave more for heirs.
Lower your risk
Think of it as a "three-bucket" strategy, Kitces says.
In one bucket you hold cash to help cover expenses for the current year. That's grocery money. Keep enough to pay bills not covered by other income, such as Social Security, a 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 preretirement and immediate postretirement years. By age 60 or 65, 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. If interest rates rise, you'll be using your dividends to buy higher-rate bonds, which will partly offset your market losses. (Prices of existing bonds fall when interest rates rise.)
The remaining 30 percent of your money goes into the third bucket, invested in mutual funds that own U.S. and international stocks. You don't expect to touch these stock funds for 10 to 15 years.
As time passes and you sell bond shares to pay your expenses, that bucket shrinks. The percentage of savings that you hold in stocks will gradually rise. You won't have to sell when the market drops. In fact, your dividends will be buying you more stocks on the 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 a year 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.)