How Investment Management Changes at Retirement

The portfolio gets a new job

During your working years the portfolio has one assignment: grow. It is funded by contributions that keep arriving regardless of what markets are doing, which means a decline is absorbed by time and by the shares those contributions buy at lower prices.

At retirement the assignment becomes harder because it is now two things at once. The portfolio still has to grow enough to outlast a retirement of unknown length and keep pace with rising costs. At the same time it has to produce spending money in every single year, including the years when selling is the last thing you would choose to do.

Those two requirements pull in opposite directions, and managing that tension is most of what changes. A portfolio built only for the first requirement can fail the second badly in its early years. One built only for the second can run short two decades later. Neither failure announces itself at the time.

What bonds and cash are actually for now

During accumulation, the conservative part of a portfolio is mostly there to dampen volatility so that the owner can tolerate holding the rest. It is a behavioral tool as much as a financial one.

In retirement it takes on a mechanical job: it is what you spend from when selling growth assets would lock in a loss. That is a different function and it changes how much of it you need and where it sits. The question stops being how much volatility you can stomach and becomes how many months or years of spending you want available without touching anything that has fallen.

This is the reasoning behind reserve or bucket structures, where near-term spending is held separately from longer-term growth assets. Whether that structure suits a particular household depends on what else funds their spending, how much flexibility they have to cut back in a bad year, and how they actually behave when markets fall. It is not automatically better than drawing proportionally across a single portfolio. It is a different way of organizing the same decision.

The underlying risk it addresses is sequence-of-returns risk, which is covered in What Retirement Income Planning Actually Is.

Rebalancing behaves differently when you are drawing

Rebalancing is familiar: when one part of the portfolio runs ahead, you trim it and add to what lagged, which keeps the risk profile from drifting.

While you are contributing, most of that can happen without selling anything. New money is directed toward whatever is underweight and the portfolio corrects itself over time.

Once withdrawals begin, there is no new money and every adjustment requires a sale. Rebalancing and funding your spending become the same transaction, which is an advantage if it is planned and a problem if it is not. Taking the year's withdrawal from whatever has run ahead accomplishes both at once. Taking it from whatever is easiest to sell, or from everything proportionally without looking, can leave the portfolio progressively more concentrated in whatever has fallen.

In a taxable account the sale also has a tax consequence, which is why rebalancing in retirement is rarely a purely investment decision.

Which account you sell from is part of the investment decision

During accumulation, account type mostly affects where you contribute. In retirement it affects every sale you make.

The same dollar of spending costs a different amount depending on whether it comes from a taxable account, a tax-deferred account, or a Roth account, and that difference compounds across a long retirement. Which holdings sit in which account type also starts to matter more, because it determines what you are forced to sell when you need cash from a particular place.

This is why investment management and tax planning stop being separable at retirement. The account structure you arrive with largely sets how much room you have to make these choices, which is covered in 401(k) Rollover Options When You Retire, and the state layer for New Jersey households is covered in How New Jersey Taxes Retirement Income.

Concentration costs more than it used to

A large single position is a common feature of portfolios arriving at retirement: company stock accumulated over a career, an inherited holding, or something that simply grew into an outsized share.

While contributions continue, a concentrated position that falls can be diluted over time by directing new money elsewhere. That option disappears when the contributions stop. Worse, if that position is also the one you need to sell for spending in a year when it has dropped, the concentration and the withdrawal compound each other.

Reducing a concentrated position usually carries a tax cost, which is exactly why it tends to be postponed. The years before withdrawals begin are generally when there is the most room to do it gradually, which is the same window that matters for most other retirement decisions. Where the position is employer stock inside a plan, the order of operations matters a great deal and is covered in the rollover article linked above.

Before and after, side by side

Why there is no single right answer

It is tempting to reduce all of this to a rule: hold a set percentage in bonds, keep a set number of years in cash, reduce equities by a set amount each year. Rules of that kind are useful for illustration and poor as prescriptions, because they ignore the inputs that actually determine the answer.

How much of your spending is already covered by Social Security or a pension changes how much the portfolio has to do. A household whose essential costs are largely covered is in a different position from one drawing most of its spending from investments, even with identical balances. Flexibility matters too: someone who can reduce discretionary spending in a bad year carries different risk from someone whose spending is fixed.

Time horizon still matters, and it is longer than people expect, particularly for a couple where the relevant horizon runs to the second death. And behavior matters most of all, because an allocation that is correct on paper and abandoned in a downturn is worse than a more conservative one that gets held.

Our investment management service describes how we work through these with clients.

Frequently asked questions