Retirement Investment Strategy: Planning Your Future

This article is an excerpt from the Shortform book guide to "A Random Walk Down Wall Street" by Burton G. Malkiel. Shortform has the world's best summaries and analyses of books you should be reading.

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What is the best retirement investment strategy? What advice will help you plan effectively for the future?

If you want to have a comfortable retirement, it’s important to have a financial retirement plan. Knowing the different options available, including lifecycle funds and annuity will help you build an effective retirement investment strategy.

Keep reading for the best retirement investment strategy.

Retirement Investment Strategy

In his book A Random Walk Down Wall Street, economist Burton Malkiel reveals his recommended retirement investment strategy. Having an allocation plan is crucial for an effective retirement investment strategy:

Recommended Allocation for Late Sixties and Beyond

  • Stocks: 40%: Half in US companies with good representation of smaller companies, half in international stocks including emerging markets
  • Bonds: 35%: Mostly no-load, high-grade corporate debt; some Treasuries, foreign bonds, and bond substitutes (high-dividend stocks)
  • Real Estate: 15% REITs
  • Cash: 10%: Money-market fund or short-term bond fund (maturity of 1 to 1.5 years)
  • Comments: A more conservative allocation to match lower capacity for risk. Allocation designed to maximize income production

Lifecycle Funds

As well as a plan for resource allocation, there are also other options to consider for an effective retirement investment strategy. This includes lifecycle funds.

A common default for corporate retirement plans, lifecycle funds are pegged to a holder’s prospective year of retirement. As the retirement year approaches, the fund automatically rebalances to a more conservative allocation. 

Most major mutual-fund companies like Vanguard and Fidelity offer lifecycle funds. Simply pick the fund pegged to the year you plan to retire. Before you do, make sure to check the expense ratio so that you’re not compromising your returns by paying hefty fees.

Saving for (and in) Retirement

The data show that Americans in general are poorly situated financially for retirement. For example, only half of Americans have retirement accounts (of any kind); among the poorest quartile of Americans, that number is 11%. A successful retirement investment strategy takes into consideration the amount you have saved.

For underprepared retirees, the options are narrow. Malkiel suggests continuing to work part time—which can have ulterior health benefits by keeping seniors active and social—and delaying taking Social Security for as long as possible to maximize those benefits. (Seniors in poor health with lower life expectancy might opt to begin taking Social Security as soon as possible to realize the benefits while they can.)

For those retirees who’ve managed to build up a nest egg, there are two primary options for ensuring your money lasts as long as you do: annuitizing your savings or holding onto your portfolio and establishing a spending rate. Malkiel recommends at least a partial annuitization of your retirement savings and, if you choose to manage your own investments, spending only 4% of the total value of your nest egg annually.

Annuities 

An “annuity”—or “long-life insurance”—is a contract with an insurance company for regular payments as long as the purchaser lives. Considering whether an annuity is right for you is part of a successful retirement investment strategy.

Malkiel’s take is that while annuities offer the security of never running out of money, they can be tax inefficient and unwieldy, especially if you want to vary your spending year over year or leave a bequest to descendants.

For retirees who’ve managed to build up a nest egg, there are two primary options: annuitizing your savings or holding onto your portfolio and establishing a spending rate. Malkiel recommends at least a partial annuitization of your retirement savings and, if you choose to manage your own investments, spending only 4% of the total value of your nest egg annually.

Establishing Your Own Spending Rate

Retirees who opt to manage their investments themselves—or only annuitize a portion of their nest egg—need to devise a spending plan that ensures they stay solvent through their golden years.

Malkiel’s solution is the “4% rule.” According to this rule, retirees should spend no more than 4% of their retirement savings annually.

Why 4%? Two reasons:

  1. 4% is likely to be below the average return rate of a diversified portfolio of stocks and bonds minus inflation. This means that the portfolio will continue to offset the reduction in purchasing power inflicted by inflation. (The formula here is portfolio rate of return – inflation = annual spend. So, if your portfolio returns on average 7% and the inflation rate is 1.5%, you could increase your annual spend to 5.5%, but see #2.)
  2. 4% also protects you from the inevitable volatility in returns. For example, although stocks may return 7% on average over the long run, there will be years when returns are less than that. If you limit your annual withdrawals in bull years, you create a backstop against bear markets

Three Further Considerations

There are three further considerations for a retirement investment strategy:

1) Regularize Your Withdrawals by Gradually Increasing Them

Because the value of your portfolio will fluctuate each year, maintaining a consistent 4% withdrawal rate may result in wide fluctuations in income. To reduce these disparities, begin with 4% but increase your withdrawal rate gradually—perhaps by 1.5% to 2% per annum.

2) Realize Gains by Rebalancing the Portfolio

It’s likely that the sum of bond interest and stock dividends won’t be enough to get you to 4% of the value of your portfolio. In this case, you should make up the difference by selling assets that have become overweighted. For example, if stocks have a banner year and your allocation has gone from approximately 50/50 to 60/40, then you should sell stocks to realize income and reduce risk. (Rebalancing annually is a good idea anyway, even if you don’t need to do so for income reasons.)

3) Put Off the Taxman

If you have monies in both taxable and tax-deferred accounts, it’s wise to withdraw from the taxable accounts first (because the more you gain in these accounts, the more you’re taxed). If you intend to leave a bequest to your children or heirs, draw on your ROTH IRA last (because there’s no required minimum distribution from these accounts, and their earnings are tax-free).

Retirement Investment Strategy: Planning Your Future

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Elizabeth Shaw

Elizabeth graduated from Newcastle University with a degree in English Literature. Growing up, she enjoyed reading fairy tales, Beatrix Potter stories, and The Wind in the Willows. As of today, her all-time favorite book is Wuthering Heights, with Jane Eyre as a close second. Elizabeth has branched out to non-fiction since graduating and particularly enjoys books relating to mindfulness, self-improvement, history, and philosophy.

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