How to Structure Your Retirement Portfolio

July 11, 2023 Rob Williams
A guide for picking the right mix of investments to help you reach your goals.

Nowadays, it's reasonable to plan for a retirement that last 30 years or longer. In fact, creating a savings plan is the first step in our three-step program for generating income in retirement.

The next step is all about choosing the right mix of investments—also known as a portfolio allocation—to carry your portfolio through. (The third step is creating a plan for withdrawing your money.)

So, how should you structure your allocation? Here are some thoughts:

1. Set aside one year of cash

At the start of every year, make sure you have enough cash on hand to supplement your annual income from annuities, pensions, Social Security, rental properties, and other recurring sources. Hold the money in a relatively safe, liquid account, such as an interest-bearing bank account or money market fund.

With this cash on hand, you won't have to worry as much about the markets or a monthly paycheck. Spend from this account and replenish it periodically with funds from your investment portfolio.

2. Create a short-term reserve

Next, we recommend creating a short-term reserve in your investment portfolio equivalent to two to four years' worth of living expenses, again after accounting for other regular income sources. This money can be invested in high-quality, short-term bonds or other fixed income investments, such as short-term bonds or bond funds. Or, if you'd rather manage individual investments, you might want to create a short-term CD or bond ladder—a strategy in which you invest in CDs or bonds with staggered maturity dates so that the proceeds can be collected at regular intervals. When the CDs or bonds mature, you can use the money to replenish your bank account.

You can use interest income and other proceeds from this reserve to cover the portfolio withdrawals mentioned in section #1. This kind of reserve can also help you weather a prolonged market downturn because you can avoid having to tap more volatile investments—like stocks—to generate cash.

3. Invest the rest of your portfolio

With a year's worth of cash on hand and a short-term reserve in place, invest the remainder of your portfolio in investments that align with your goals and risk tolerance. Your overarching goal here should be to hold a mix of stock, bond, and cash investments that can generate growth, provide income, and preserve your capital.

What works best for you will depend on your age, income needs, financial goals, time horizon, and comfort with risk. And it's fine to change things up over time. For example, you might feel comfortable taking more risk in the early years of retirement in exchange for more growth. You could grow more conservative later on, with a focus on preserving your capital and generating income.

Here's how that might look. Notice how the share of more-volatile stocks shrinks relative to cash and bonds over 20-plus years:

Adapt your strategy over time

During your early years of retirement (age 60-69), consider a moderate asset allocation consisting of 60% stocks, 35% bonds and 5% cash and cash-like investments. From age 70-79, consider shifting to a moderately conservative allocation of 40% stocks, 50% bonds and 10% cash and cash-like investments. At age 80 and older, consider shifting to a conservative allocation of 50% bonds and 20% stocks, 30% cash and cash-like investments.

Source: Schwab Center for Financial Research. The example is hypothetical and provided for illustrative purposes only.

Retirees who adopted this plan would have seen the following results in their portfolios*:

The moderate portfolio’s best year was up 31%, average was up 9%, worst was down 21%. Moderately conservative best was up 27%, average was up 8%, worst was down 13%. Conservative portfolio’s best was up 23%, average was up 7%, worst was down 10%.

Source: Schwab Center for Financial Research with data provided by Morningstar, Inc.

*Based on data collected from 1970 through 2022.

The return figures represent the best and worst total returns, as well as the compound average annual total returns, for the hypothetical asset allocation plans. The asset allocation plans are weighted averages of the performance of the indexes used to represent each asset class in the plans and are rebalanced annually. Returns include reinvestment of dividends and interest. The indexes representing each asset class are S&P 500® Index (large-cap stocks), Russell 2000® Index (small-cap stocks), MSCI EAFE® Net of Taxes (international stocks), Bloomberg Barclays U.S. Aggregate Bond Index (bonds) and FTSE U.S. 3-month Treasury bills (cash investments). The conservative allocation is composed of 15% large-cap stocks, 5% international stocks, 50% bonds and 30% cash investments. The moderately conservative allocation is 25% large-cap stocks, 5% small-cap stocks, 10% international stocks, 50% bonds and 10% cash investments. The moderate allocation is 35% large-cap stocks, 10% small-cap stocks, 15% international stocks, 35% bonds and 5% cash investments. CRSP 6-8 was used for small-cap stocks prior to 1979, and Ibbotson U.S. 30-day Treasury Bill Index was used for cash investments prior to 1978. Past performance is no guarantee of future results.

Because stocks can be more volatile than other investments, you many wonder why you should have any allocation to them in retirement. The short answer is: Growth potential.

Gains from stocks have historically helped investors keep pace with inflation and taxes—doing a better job than bonds or cash.1 The key is having enough to keep your portfolio adequately inflated without exposing you to the risk of having to sell depressed assets during a downturn.

1Schwab Center for Financial Research.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risks including loss of principal.

Diversification, asset allocation and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when a nonretirement account is rebalanced, taxable events may be created that may affect your tax liability.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk.

Small cap stocks are subject to greater volatility than those in other asset categories.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.

A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio. As compared to other fixed income products and strategies, engaging in a bond ladder strategy may potentially result in future reinvestment at lower interest rates and may necessitate higher minimum investments to maintain cost-effectiveness. Evaluate whether a bond ladder and the securities held within it are consistent with your investment objective, risk tolerance and financial circumstances.