The concept of portfolio distribution sounds more complex and mysterious than it really is. A well-designed portfolio is one that meets your financial needs throughout your lifetime–and even after, in the case of a legacy.
Good portfolio distribution incorporates the principles of risk management, with the goal of helping you to achieve financial independence. Unfortunately, too many people nearing retirement approach portfolio distribution without a real understanding of the implications of various distribution models.
As you approach retirement there is somewhat of a natural assumption that you need to “get conservative” with your investments and take on less risk. The belief is that as you age and enter retirement, more of your portfolio should be allocated to bonds so as to produce income that can then be spent during your retirement years. While bonds play a very important role in nearly every portfolio, automatically shifting a large portion into bonds may not achieve the results you want.
The problem with this approach to retirement income planning is that even in our low inflation rate environment, it is likely guaranteeing that you will lose the purchasing power of your retirement income. If you have a very high risk capacity (a very large portfolio relative to how much money you “need” to spend each year), then inflation might not be as much of a problem. For most investors though, inflation needs to be taken very seriously.
Today, we’re seeing clients living longer than they were even 25 years ago. A healthy 65 year old retiring today will probably live another 20-25 years, or more. It makes little sense to assume that we will be in a low inflation environment for another 25 years. Re-allocating a large portion of a portfolio from equities into bonds may in fact be taking on a great deal more risk than you ever imagined. Typically, interest rates rise in an effort to fight inflation. Bonds cannot and will not prove to be a hedge against inflation. Getting “conservative” and migrating heavily into bonds could very likely be a costly decision.
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