Key Takeaways
The makeup of your investment portfolio should change according to your risk tolerance as you approach retirement.
While stocks and bonds help with growth and income potential, retirees often need cash reserves for short-term goals and emergencies.
There's no one-size-fits-all answer for cash reserves. The amount you need should be considered as part of a well-diversified portfolio.
Are you closing in on retirement or already retired? Even at this stage of life, market risk could still threaten your savings.
After all, many people will keep money in the stock market for growth potential and the bond market to seek income after they've retired. But no one really knows how the markets will move or how much their assets will increase or decrease in value. That's where cash reserves can help.
Simply put, your cash reserve is the money you need for emergencies and short-term needs. It could be in the form of cash equivalents (money markets, certificates of deposit) or other savings accounts.
How much could you need? Here's where to start.
Review Your Cash Reserve Plan
Holding too much of your retirement nest egg in lower-risk investments may not provide the growth potential you need. Not only do you want growth to build wealth over time, but you also need it to outpace inflation. If the rate of growth is lower than the rate of inflation, you're effectively losing money because your purchasing power is decreasing.
That said, holding a cash reserve can be a practical choice as you enter and travel through retirement.
How Much Should You Hold in Your Cash Reserve?
The specific amount will depend on your age, total savings, lifestyle plans and monthly expenses. Your cash reserve could make up as little as 5% of your portfolio, or 20% or more, according to your specific needs:
Emergency fund.
You'll want to keep an emergency fund on hand—liquid, accessible assets that you can tap if the unexpected occurs. That might be a sudden medical bill, an unexpected home repair or a blown transmission on your car.
Time.
You'll want to think about the timeframe driving your cash reserve. Some experts have suggested holding enough cash to cover three to six months of expenses; others say one, two or even three years.
Income.
You'll want to guard against market downturns. Without cash in reserve, you could be forced to sell investments for monthly income. And that could mean selling at a loss instead of waiting out the downturn and potentially recouping those losses and selling when the price is higher.
Reevaluate Your Risk Tolerance
As you move toward and through retirement, the makeup of your portfolio should probably change. That's in part because yourrisk tolerance evolves over time.
Think of it this way: When you still have decades before retirement, you're in a position to recover (and maybe even make gains) after a market downturn. Your portfolio might include a heavy weighting toward stocks with higher growth/higher risk potential.
But as you inch closer to retirement, you'll have less time to make up for any losses. You'll likely want to increase the percentage of your portfolio allocated to lower-risk investment choices. The key is to position your portfolio to maximize the chances that your hard-earned money continues to grow without exposing yourself to unnecessary losses.
Remember Diversification
No matter how closely you watch the market, you can't predict its movements with certainty—no one can. As you know, that unpredictability can cost you if you put all your eggs in the wrong basket. And, if you're approaching retirement—or already there—it may be harder to bounce back from that loss.
What strategy might help you temper an unexpected blow to your portfolio? Just as it was when you opened your first investment account,diversificationis still the answer.
Diversification means spreading your money across several types of assets—usually stocks, bonds and cash equivalents. Diversification takes advantage of the fact that different assets respond differently to shifts in the market. When some go down, others may go up.
Stocks. Investing in stocks generally provides higher growth potential but more exposure to market volatility.
Bonds. These debt securities are typically less volatile than stocks but offer lower return potential. Most provide regular income payments, which may serve as a buffer against more-volatile assets.
Cash. Cash equivalents include money markets, certificates of deposit and other high-quality accounts offering relative stability and lower risk than stocks and bonds.
Diversification doesn't guarantee a profit or protect against loss. However, it may help smooth out the ups and downs that accompany investing in the financial markets.
With the appropriate strategy, you may be able to lower risk while keeping your financial goals on track. And that can help you build your savings to support the retirement of your dreams.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Diversification does not assure a profit nor does it protect against loss of principal.
You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
