It's completely natural for your financial goals and mindset to evolve as you age. At age 25, you might be focused on paying off student loans and saving up for your first home. While at 50, you're starting imagining a time when the career hustle—and the income that comes with it—won't be a part of your life anymore. As your life changes, your investment decisions must adapt as well.
Investment Risks Over Time
Since young adults won't be withdrawing for years, they have time to recover and recoup from any losses from either sudden or long-term market downturns. As a result, younger individuals may have a higher risk capacity for the portion of their investment portfolio dedicated to retirement savings.
However, someone who's only a few years away from retirement won't have as much time to recover from a plunge in the markets. So, they may be better suited to a low-risk strategy. If a near-retiree's portfolio relies too heavily on stocks, their retirement could be jeopardized by a market downturn. They may be unable to recoup their losses and can rapidly drain other resources while trying to accommodate this loss of income. As a result, many individuals close to retirement have a lower risk capacity. Therefore, their portfolio should lean more heavily on less volatile income sources, such as bond funds.
Please note: we are assuming that you plan to retire in your mid-60. If you want to retire earlier, you will need to make changes earlier. We do not recommend planning to work past 70. While many people may desire to work longer than some of their peers, it is not prudent to assume you will be able to do so.
Investing In Your 20s
When you first start out, most of your investments will be cash in the bank. You should be building up your emergency fund and perhaps setting aside money for a down payment on a home. Yes, you may have some retirement savings, but at first, this should be dwarfed by your bank accounts.
You may have heard that people in their 20s can take risks with their investments, but that typically only applies to their retirement savings. A 20-something's entire portfolio, including bank accounts, should typically be conservative compared to the overall portfolio of someone with higher savings. Frequently someone in their 20s will have an overall portfolio that is more conservative than their parents. Typically, the portfolio of someone in their mid-20s is made up of lots of cash with some stocks in retirement accounts. Very rarely do we recommend substantial bond positions for people in their early careers.
Your main savings vehicles will be savings accounts and retirement accounts such as IRAs, Roth IRAs, and 401(k)s. Since your tax bracket is likely lower than it will be in the future, Roth accounts can be excellent options.
Investing In Your 30s
By the time someone is in their 30s, they have frequently built up enough savings that their emergency fund no longer takes up most of their overall portfolio. However, with 30-plus years until retirement, it is still a good time to focus on investment. It's common for those in their 30s to have the majority of their retirement savings invested in stocks. Still, some may want to start diversifying into bonds.
As your income and spending grow, you may want to plump up your emergency fund. Still, most of your investing should take place in retirement accounts. If you have maxed out your retirement savings, use taxable brokerage accounts. This is also when many people purchase their first home.
Investing in Your 40s
By the time you hit your 40s, your emergency fund should be dwarfed by your retirement savings. But, since you are still a couple of decades out from retirement, you may still have a moderately aggressive retirement portfolio. For this reason, your complete portfolio allocation may be at its most aggressive in your 40s, even as your retirement assets diversify into bonds.
Your investment allocation in your 40s will depend on how much you have been able to accumulate so far, how close you are to retiring, and your risk tolerance. Throughout your 40s, bonds will begin to be a vital portion of your portfolio.
As you inch closer to your peak earning years, your 40s can be a good time to shift from primarily Roth savings to traditional tax-deferred retirement accounts. Many people start to strain against retirement contribution limits in their 40s, so you may want to open a taxable brokerage account for your excess retirement savings.
Investing in Your 50s and 60s
How you choose to invest in your 50s and 60s will hinge on how your current financial picture aligns with your upcoming retirement goals. Review your current income level, spending, nest egg, taxes, and projected retirement income. These factors will help you determine how aggressive your portfolio should remain throughout your 50s and 60s.
Now's the time to focus on making sure your income and assets in retirement are stable while still allowing for portfolio growth. This means focusing on how on bonds and cash you need for your future spending and how you can still invest in stocks once you have filled this need. Incorporating an appropriate amount of risk into your portfolio can help you prepare to experience the kind of retirement you want. While we believe that consulting professional financial advisors throughout your adulthood is helpful, it becomes vital in your 50s and 60s because that is when the investment and retirement rules of thumb fall apart.
Investing in Retirement
Our general approach to investing in retirement is to have at least enough cash to cover your next three years of expenses not covered by fixed income (pensions, annuities, and Social Security) and a minimum additional ten years of bonds. This will help you weather most market downturns without needing to sell your stocks when they are down. How you should invest the rest of the portfolio depends on your goals for yourself and your heirs.
Developing an investment strategy is based on a wide variety of factors, and it's always important to take your age and proximity to retirement into account. As you analyze your portfolio's asset allocation, remember that diversifying and protecting your future retirement income is essential. Reflecting on your investment strategies and consulting with a financial professional can create peace of mind as you approach retirement age.