What To Include in Your Retirement Portfolio

An investment portfolio is a collection of assets that a person buys or funds, with the hopes that they grow in value over time. One of the most common reasons why people build investment portfolios is to support their standard of living in retirement, when they will have left the workforce and stopped receiving a regular paycheck.

Drawing the most impact from your retirement portfolio requires careful consideration of your needs, your characteristics, and the diverse variety of assets from which to choose. The difficulty, though, is knowing precisely what to include in your retirement portfolio. To help you plan for your retirement, let’s look at what your options are.

What To Include in Your Retirement Portfolio

Whether you’re investing for retirement or wanting to grow your wealth, the rule of thumb is to achieve diversification — the state of having a variety of assets in your portfolio, each offering different expectations in terms of its risks and potential returns. To that end, a well-diversified portfolio might include the following instruments:

Annuities

An annuity is an insurance product that you fund with either a lump-sum payment or a series of contributions over time. It can be immediate (paying out disbursements within a year) or deferred (paying out at a future time, in some cases several decades). When you purchase an annuity, you determine the contract term and the insurance company invests your contribution in assets that allow it to grow tax-deferred. At the end of the term, you can convert the contract into regular cash payments that last for the rest of your life or for a specified length of time.

There are three main types of annuities to choose from:

• Fixed: A fixed annuity provides a set interest rate of return for the life of the contract, allowing for easy predictability concerning how much total money you’ll receive in disbursements. Because the interest rate does not fluctuate, fixed annuities are a relatively safe instrument for risk-averse people.
• Variable: With a variable annuity, you select the assets that the insurance company will invest in, and the rate of return on your contributions depends on how well those assets perform. Your upside potential increases in years of strong market performance, but it also decreases when the market does poorly. Therefore, variable annuities present some degree of risk.
• Indexed: An indexed annuity is tied to an underlying market index, such as the S&P 500 or the Dow Jones Industrial Average. As with variable annuities, your rate of return fluctuates along with the index’s gains and losses, but your principal remains protected because the interest rate cannot sink below 0%. However, the insurance company may place limits on your upside potential, namely participation rates, spreads, and caps.

Stocks

When a company goes public — that is, when it decides to become a publicly owned entity, typically to raise capital — it sells shares of ownership called stocks. Every share of stock you purchase earns you a piece of the company’s profits, which you might receive as a dividend. Factors such as supply and demand, economic forecasts, market sentiment, and the health of the company can cause the stock value to appreciate (go up) or depreciate (go down). 

If you own a particular stock that appreciates over time, you make a profit by selling it. Say, for example, you buy 20 shares of a stock at $20 each, for a total valuation of $400. Should the stock appreciate to $100 per share in 10 years, it will have appreciated by 400%, increasing your total stock value to $2,000 and netting you a profit of $1,600.

Bonds

A bond is essentially a loan that you give to an issuing entity — normally, a corporation or government that needs to raise capital. In exchange for your loan, the issuing entity offers a fixed rate of interest, for a specific length of time, on the amount given. This is known as the coupon rate. To illustrate, imagine that you buy a $15,000 bond with a 5% coupon rate and 10-year maturity date. Because 5% of $15,000 is $750, that is how much interest you will earn every year for 10 years, meaning you’ll gain $7,500 on your investment.

As with most assets, lower-risk bonds tend to offer lower interest rates and higher-risk bonds offer higher interest rates. There are also three primary types of bonds, which are:

• U.S. Treasury bonds: Backed by the federal government, U.S. Treasury bonds are among the safest forms of investment but tend to offer low interest rates.
• Municipal bonds: These bonds are issued by non-federal government entities, such as counties, cities, and states. Some municipal bonds may be tax-exempt.
• Corporate bonds: Similar to stocks, corporate bonds are issued by companies looking to raise money. However, unlike stocks, they do not confer profit ownership to the bondholder.

The Importance of Diversification

The importance of portfolio diversification lies in its ability to minimize risk while maximizing upside. Stocks, bonds, and annuities each offer different degrees of risk and benefit, so the objective is to create buffers by which the upside potential of one asset type can cover for the downside potential of the others. 

Stocks, for example, are more volatile than bonds and annuities. If your portfolio is entirely stocks, an economic downturn could cause you to lose both your gains and your investment principal. However, with enough bonds and annuities in your portfolio, the gains realized on those other assets could mitigate your stock market losses or even allow you to realize gains overall.

Tips for Creating a Strong Portfolio

Consider these tips to build the strongest retirement portfolio possible:

• Establish safety nets: Portfolio diversification has its limits, so you might want to protect yourself against downside by ensuring you have enough cash on hand. At the start of every year, try to have enough cash to cover your expenses, and have up to four years’ worth of living expenses in relatively liquid accounts — assets that are easily converted to cash.
• Strike a balance between income and growth potential: Having a portfolio of long-term, high-growth assets may benefit you down the line, but you still need money in the interim while your assets appreciate. A couple of ways you can strike the balance between income and growth are to have dividend-paying stocks in your portfolio and to build an annuity ladder, by which you have several annuities that begin to pay out at different points.
• Adapt your portfolio to your changing needs: What you require from your portfolio is likely to change over time. When you’re younger, you might want a more growth-oriented portfolio to accommodate your expected longevity, while your later years may require more liquidity.
• Don’t forget about other sources of income: What savings do you expect to have by the time you retire? How much will you get in Social Security and pensions? If these other sources of income can cover the crux of your living expenses, you could afford a higher-risk and higher-reward portfolio.

Retirement planning can be a complex, long-term process, so it’s important to get the input of an expert. Consider speaking with a financial adviser to develop a retirement portfolio tailored to your financial goals, expectations, and timeline.