Transitioning Your Portfolio’s Focus from Growth to Income as You Approach Retirement

Older Americans continue to roll the dice in the stock market, ignoring the conventional wisdom to protect their nest eggs by moving more of their investments to bonds and other income-producing assets. This is one of the most common oversights among investors approaching retirement, and it could also be the costliest.

According to a recent study by Fidelity Investments, Baby Boomers are more likely to employ a hands-on approach to managing their money than other generations. Among Baby Boomers with retirement accounts at Fidelity, 53% pick their own investments entirely, compared to 42% of Generation X and 25% of Millennials. What’s more, nearly half of those older investors managing their own money held more than 70% of their portfolio in stocks.

On the surface, it's easy to understand why Baby Boomers resist heeding recommendations to de-risk portfolios and incorporate income-generating investments as they age. Since U.S. stocks bottomed in March 2009 (following the Great Recession), the S&P 500 Index has notched a total return of more than 700%, compared with the Bloomberg U.S. Aggregate Bond Index’s total return of about 46% for the same period. But what happens when it’s time to turn that collection of stocks into an income stream capable of covering typical living expenses, such as food, transportation, and housing?

A portfolio centered solely on growth is unlikely to produce enough income to sustain a retiree’s lifestyle on its own, which means you will need to periodically choose which investments to sell—regardless of whether the market at the time is in positive or negative territory—to cover your monthly expenses. Consequently, you may be forced to sell off a significant portion of your portfolio prematurely, ultimately cementing any losses.

This is why a growth-focused portfolio can be risky for retirees. Moreover, as you get closer to retirement, you have less time to recover from potential market downturns. By contrast, an income-focused portfolio can provide you with more stable and predictable returns. It can generate cash flow from dividends and interest (which can be used for living expenses) ultimately reducing the need to sell investments in a down market.

Reallocating to an income-focused portfolio involves investing in assets that regularly generate cash flow, such as bonds, dividend-paying stocks, real estate investment trusts (REITs), and annuities. These investments can provide a steady stream of income to cover your living expenses during retirement.

In retirement, you will likely be relying on investments to replace your regular paycheck. However, shifting the focus of your portfolio does not mean you have to abandon growth stocks entirely. What’s important is striking the proper balance between growth for the future and income for today. This balance will depend on individual circumstances like age, monthly expenses, and your willingness to take on investment risk as well as your capacity to do so.

For example, a person who manages to cover a healthy percentage of their monthly budget using fixed income sources (i.e., a pension and social security) might not need their portfolio to generate much income to address any shortcomings. It might be possible to get by on the dividends paid by high-quality, blue-chip stocks alone.

However, a person who has high monthly expenses or does not receive a pension might need to cover the vast majority of their monthly expenses using distributions from their investment portfolio. This would require more of a focus on investments with a higher interest yield.

One strategy that can assist with this transition is the bucket approach. This involves dividing your portfolio and allocating your money into several “buckets” based on when you'll need it. Money for immediate expenses is kept in cash and short-term investments, while money for future expenses can be invested more aggressively. This way, one account or “bucket” can provide a steady stream of income for today, while other accounts still allow room for growth.

As we approach retirement, our financial priorities naturally shift. Where we were once focused solely on maximizing growth and building wealth, the emphasis ought to eventually be placed more on preserving that wealth and generating a steady income. This transition is crucial to ensuring a comfortable and secure retirement. It's not just about having enough money to live on; it’s also about managing risk and ensuring that your savings will last as long as you do.

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Malcolm Ethridge, CFP® is the Managing Partner of Capital Area Planning Group based in Washington, DC. He is also the Managing Partner of Capital Area Tax Consultants. 

Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits. 

 Disclosures:

The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.

Investments in securities and insurance products are:

NOT FDIC-INSURED | NOT BANK-GUARANTEED | MAY LOSE VALUE