Have you noticed, as you age, that your body needs a little more recovery time to heal from an injury? We don’t bounce back as easily as when we were kids. Your retirement portfolio has different phases in its life too. And what’s fine in one phase, might not work so well in another. The two main phases are the accumulation and the distribution phases. I’m going to discuss a few general differences between how you should treat your portfolio in these phases. As always, this is meant to be educational and may not apply to your particular situation. Be sure to check with your financial advisor to see what’s appropriate for you.
The accumulation phase is when you’re working and saving money for retirement – you’re accumulating investment assets. Just as when you’re young, this is the time to make mistakes. You might get spooked by a big drop in the market and sell all your stocks or stock funds. While this is never good, it’s understandable; especially when it’s the first time you’ve suffered a major loss. [Hopefully, you won't panic after you've weathered a few big downturns over the decades.] As you continue investing over the years; you’re able to make up for the past mistake and see your portfolio recover nicely.
The big difference with the distribution phase is that you are, not only, no longer adding to the investments; you’re taking distributions and may see the size of the portfolio decrease if you take out more than the total investment return. If you are living off a combination of Social Security benefits and your investment income, try not to kick your dog while it’s down. In this case, the dog is the stocks or stock funds (equities) in your portfolio. Over the long run, it is the equity portion of your portfolio that you look towards for long-term growth. If you sell a portion (or all!) of the equities while the market is down, your portfolio may likely never recover. This could lead to your running out of money. Ideally, you should keep enough cash and fixed income (bonds or bond funds) in your portfolio that you wouldn’t need to sell the equities on a downswing. You might also consider an immediate annuity (perhaps with an inflation adjustment), upon your retirement for a portion of your portfolio. An ideal situation would be to cover your basic living expenses with a combination of Social Security and the annuity. If you did this, the equities in the remainder of your portfolio could be left to grow for the long term.
Another difference between the accumulation phase and the distribution phase is in how you should handle rebalancing. You should have defined what percentage of your portfolio should be invested in the various asset classes (or subclasses). As the investments in the asset classes change value, the percentages shift and you will need to rebalance the portfolio. During the accumulation phase, it is ideal to use cash to purchase more of an investment which has dropped below the desired percentage of the portfolio. In this way, you are maintaining the correct allocation and you’re always building up the portfolio. However, once you’re in the distribution phase, if you need the cash, you will have to rebalance by selling a portion of the appreciated asset class to buy more of the depleted or depreciated funds.
The big takeaway is this: buy low, sell high. Once you’re retired, have your portfolio properly allocated so you will never feel the pressure to sell any of your equity funds while the market is down.
