All great chefs know the secret to great cooking is mixing the right ingredients in the right amounts. Turns out putting together the perfect retirement portfolio isn’t much different. As in cooking, you have to start with the right basic ingredients—in this case stocks and bonds—but if you get the proportions right, the result will be a huge success.
To figure out the right mix for your retirement needs, start with a few simple questions. How long will the money stay invested? How much risk are you willing to take with your savings? How much growth do you need? “The only way to properly answer those questions is to put together a comprehensive financial plan that sets out your short- and long-term financial goals,” says Marc Lamontagne, a fee-only adviser with Ryan Lamontagne in Ottawa.
The biggest and most important question you’ll likely face is how to balance your risk with the amount of growth you need. Generally speaking, the longer your money is invested the more risk you can afford to take on. But how do you determine your tolerance for risk? “I like to use a questionnaire with my clients,” says Lamontagne. “It allows us to open up a discussion that allows us to gauge their risk tolerance. If they’re a couple and they each have a very different tolerance for risk, then I generally help them reach a compromise, keeping in mind that the compromise will allow both of them to reach their financial goals.”
To get the maximum return while taking the minimum amount of risk, it helps to think of your portfolio as being split into two parts: an equity portion comprised of stocks, and fixed income portion made up of bonds, GICs and savings accounts. Generally speaking, the higher the percentage in equities, the higher the risk.
Keep in mind that while stocks will earn you a higher return over the long run, their short-term performance is harder to predict. If you’re 30 and retirement is a long way away, you can take a few market crashes in stride and still come out ahead, so you can take on more risk. But if you’re getting close to retirement, you should probably decrease your stock holdings and go heavier on bonds, as they’re more predictable so you’ll suffer less damage from a market slump.
A good rule of thumb is to put a percentage in fixed income that is equal to your age. If you’re 40, for instance, you could put 40% in fixed income and 60% in stocks. If you’re 60, you could put 60% in fixed income and 40% in stocks. The exact proportions depend on your risk tolerance. You can also help insulate yourself from market declines by building up a pool of cash and GICs, or a short-term bond ladder. If you build up enough to fund three years’ worth of expenses, you won’t have to sell off stocks when the market is down.
Still, you don’t want to get too conservative: “If a retirement portfolio is to last you to age 90, it should not be invested only in cash and GICs,” says Norm Rothery, a chartered financial analyst and founder of StingyInvestor.com. “There should be a minimum 25% holding of equity—regardless of age. Such a portfolio actually has less risk than one invested 100% in fixed-income investments because it will protect you from the risk of inflation.”
Once you’ve established the right mix of equities and fixed income, then it’s time to choose your individual -investments. The -investment vehicles you pick depend on several factors, including the amount of time you want to spend on your portfolio. You can buy individual stocks and bonds, but this is best left to more experienced investors. Mutual funds and index funds are likely more convenient and practical.
If you’re a new investor, then a simple balanced mutual fund can be a great place to start. “They usually contain a conservative 60% equity and 40% fixed income mix all in one product,” says Rothery. Experienced investors who want a more hands-on -approach may also want to look at exchange traded funds (ETFs) or index mutual funds.
For a more detailed analysis of the right mix for you, consult a knowledgeable -adviser, who can help you pick the perfect investments for your particular situation and goals. Check back with your adviser regularly to ensure that your overall mix and risk level stay on track as your financial situation and time horizon changes.