I'm 60 with $2 Million: What's the Right Investment Allocation to Retire in 5 Years?

So you're 60 years old with $2 million in your portfolio and you want to retire in five years, but you want to know what's the right investment allocation for you. Today we answer that question and more. Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial, a certified financial planner, and we're here to discuss investment allocations in retirement.

We're going to be discussing a situation, a case specifically of a couple that are 60 years old, they have $2 million saved in their retirement portfolio, and they want to retire in five years, spending about $120,000 a year. But they want to answer this question, how conservative should I be? How aggressive should I be? What should my investment allocation look like today, over the next five years, and throughout retirement? We're going to be taking a dive into that specific case and looking at some real numbers. Before we get there, we're going to take a look from a high level of some of the very important things they should be paying attention to.

We're going to start this with taking a look at the impact of their account value versus the contributions. This is an important concept, so stick with me. This is a chart that shows this blue line, that is the impact of your contributions to say your 401k over time.

Now in those early years, the impact to your account value for an additional contribution is much greater than it's going to be as you get closer and closer to retirement. That's important. In those early years, you put in $10,000, well the impact of the change of that account value was all due to that $10,000 that you added.

Now once that portfolio grows to $2 million and you add 10 grand, well that didn't make nearly the impact that say a 5% movement in the stock market could make. That 5% movement could change the account value by $100,000. So this is really just emphasizing the importance of something known as the portfolio size effect.

As you get closer to retirement, the size of that portfolio and the fluctuations you experience in the market have a bigger and bigger impact on your ability to reach retirement and stay in retirement. And there's a couple important concepts that we need to understand around that retirement date, which are on this next slide. So in this retirement date, you have two different zones to pay attention to.

As you get closer to retirement, that first zone that you hit is something that we call retirement date risk. And that retirement date risk is typically about 10 years out from retirement. So about 10 years out from retirement, we have to pay much closer attention to fluctuations in the market and how we're allocating that portfolio.

Because any fluctuations in that 10-year window could have a major impact on our ability to hit that retirement date, then stay in retirement. Then the next phase, we have something that you may be more familiar with, and that's something known as sequence of returns risk. And that lasts somewhere between 10 and 15 years.

Those first 10 and 15 years in retirement, you have sequence of returns risk as your number one risk of staying in retirement. What is that? Well, that is the impact of the sequence of returns that you get on your portfolio in retirement. Now, if you had really bad returns overall, over a 30-year retirement on the back end of your retirement, it would have very little impact on whether you ran out of money or not.

If you had those bad returns on the front end of retirement, say in those first 10 or 15 years, it would have a much more dramatic effect on your ability to stay in retirement. What's happening is you're violating the number one rule of investments when you step into retirement and the market's depressed. The number one rule of investments is you buy low and sell high.

If the market's down and you take a distribution, you are now violating that rule of investments. You're selling when the market's down. On your way to retirement, it's quite the opposite.

Your dollar cost averaging into the market. So when the market's depressed, you essentially buy more of the market, essentially timing the market. When the market's more expensive, you buy less of the market.

And so you're essentially, again, timing that market. It's a very effective way to save money and get yourself to retirement. But when you start taking withdrawals, the opposite happens.

Some call this reverse dollar cost averaging. And this is why it's so important to really focus on your investment allocation during this window of 10 years before retirement and 15 years after retirement. Now, as I'm going throughout this video, if you have any questions about anything that I am talking about, anything comes to your mind and you want to ask me, just drop it in the comments section.

And I'll answer each and every one of those questions as I follow up on this video. Now, let's take a look at this next picture, because this is what most people's investment allocation looks like on the way to and through retirement. You might be doing this.

If you have a 401k, there's a very good chance that you own a target date fund. And those target date funds are reallocating or rebalancing your portfolio towards fixed income year after year, allowing that portfolio to automatically get more and more and more conservative each and every year. And that never stops.

There's something also known as the rule of 100, which is kind of the foundation of investment allocation and the way many people are allocating their retirement portfolios. This is the way retirement target date funds work. You essentially take your age and put a percentage behind it.

That's how much you should have in fixed income, or that's how much you should have in bonds or a conservative allocation. So when you're 60 years old, you should have 60% fixed income. When you're 20 years old, 20% fixed income.

80 years old, 80% fixed income. 90 years old, 90% fixed income. It works in a very linear fashion.

And I think we have to ask ourselves, how much sense does that really make? Especially at this end of the curve. I mean, we could look at this end of the curve and recognize pretty easily that a 20-year-old probably has no reason to own any fixed income whatsoever. This is just a rule of thumb, and it should be thought of as such.

Now, at this end of the curve, when you're 90, should you really have 90% fixed income? This is going against conventional wisdom that we often think about that, oh, well, grandma's 90 or mom's 90, and she needs to be more conservative because she doesn't have much time left. If grandma has $3 million and she's spending $50,000 a year and she loses 50% of that $3 million, now it's worth $1.5 million, is she going to run out of money? Probably not. However, the 60-year-old that's spending those dollars, they have $2 million.

It goes to $1 million. They were spending $50,000 a year. Now they take a distribution from what's now $1 million.

They're going to be taking a much larger chunk out of that portfolio. They're actually running the risk of running out of money. We could actually be more aggressive, arguably, and this is what the research is showing us, is that we could be more aggressive and have a better result at the end of the day, more spendable income, more assets to leave behind if we don't continually and linearly get more conservative each and every year.

What should that look like? Well, it should look a little bit more like this, and this is called a bond tent, and that is because it looks like a tent. This line is our bond allocation over time, and instead of increasing our percentage allocation of bonds every single year linearly, the latest research is showing us we're going to get much better results, even stress-tested, if when we're in that retirement date risk zone, so about 10 years out of retirement, we increase that fixed income allocation at a faster rate to battle what's going to be sequence of returns risk to make sure we hit that retirement date, and then we spend down the fixed income first, starting to spend down that fixed income until we hit about a 60-40 portfolio. That's 60% equities, 40% fixed income for the remainder of our lives after we're 15 years into retirement.

That is going against that conventional wisdom, but you can see the impact that that's going to make overall, and another thing that people are often doing, I mean, we're talking about a situation where someone is spending down their fixed income first while they let their equities grow. This is the way it should be done. Most often, what I find, though, is individuals, investors, or planners even are creating what they think is a retirement income portfolio, where maybe you have a 60-40 mix, and you're ratcheting that allocation of fixed income or bonds up every single year, but you're just indiscriminately taking 4%, 5%, 6% out of every holding in that portfolio every year.

We should be spending the lower-yielding assets down first and letting those higher-return assets or equities grow over time, and that's what we're seeing with that latest research, and that's what's really happening when we're creating a bond tent. But now, I want to show you a real example. I want to show you what the math actually looks like over time.

So now we're going to take a look at our financial planning software here at Howard Bailey Financial. If you see this, you want a scenario like this ran for yourself, all you have to do is call the number on your screen, visit for free with one of our fiduciary financial planners. No matter where you're at in the country, we'll visit with you online and run some numbers and projections like this for you.

Now, in this scenario, we're looking at John and Jane. So we have a John and Jane here, and they're making a pretty good living, making about $200,000 a year, $120,000, $80,000 a year. They're 60 years old, a little over 60, but they're going to retire at age 65.

So we now have them about five years out from retirement, specifically four and a half years out from retirement. They have some solid social security benefits, about $2,800 a month for John. Jane has about $2,000 a month.

And we're also applying a cost of living adjustment to those social security benefits at 2.75% per year. This is a historical number. It may be a little bit lower or higher than what you've seen lately.

But that is a number that reflects a conservative number for us to inflate those social security benefits at over time. Now, should they take it at age 65? That's not the question that we're answering here today. We're taking a look at a high-level example.

And if you want to take a look at how we get deeper into social security planning and really figure out should they file at 70, should they file for spousal benefits and other options, take a look at another one of our videos we've produced around social security benefits in-depthly. But right now, we just want to take a look at the bond tent scenario and compare a couple of different scenarios here. We have their assets, all in traditional IRAs, $2 million.

We have $1.2 million that we've allocated to fixed income here. And we've allocated $800,000 to equities. So let's think bonds, let's think stocks, right? 1.2 in bonds, $800,000 in stocks.

And so that is, they're 60 years old, that's a 60-40 mix. 60% allocated to fixed income, 40% allocated to equities. And they want to spend a good amount in retirement.

They're planning on spending $8,500 a month in retirement. We're going to inflate those expenses at a historical inflation rate of 3.27% per year. Are they going to have that spending pattern? Well, that spending pattern has to be unique to you.

It's going to need to be unique to them as well. Maybe they want to spend more on the front end. Maybe you want to spend less on the front end and more on the back end.

You can create those patterns for yourself and really customize this and get into the nitty-gritty. But for this example, they're going to spend about $120,000 a year when they reach that retirement date because we're inflating it. And we're inflating those dollars forever.

And what happens in retirement? Well, in retirement, they're doing pretty well in those early years. So they retire in 2029. They're 65 years old.

They have about $5,000 a month in Social Security. They need $10,000 a month in order to meet their expenses. So they have an income gap of about $60,000 per year.

They're going to have to take withdrawals from their portfolio to meet their income needs. And over time, they're doing pretty good preserving that principle in those early years. Over the first 10 years, they have 2.5. They end with about 2.5. And they continue to preserve that principle until they're in their mid-80s.

And then that portfolio value starts to go down quite precipitously. Why is that? Well, one, we do have much more in expenses there. Now they're spending, instead of $10,000 a month, they're spending $20,000, $25,000 a month due to the inflation rate that we leveraged for this scenario.

In addition, they're allocating more and more of those dollars over to fixed income. They're rebalancing according to those old Rule of 100 guidelines, where at 70, they have 70% fixed income. At 80, they have 80% fixed income.

90, 90% fixed income. And because we would expect a much lower return in that fixed income world, they're going to be eating into that principle at a much, much higher rate as those years go on, largely due to that rebalancing in conjunction with that inflation rate. So what if instead they used the bond tent approach? So we're going to take a look at what those accounts look like over time and that fixed income allocation and what's happening.

In 2029, they are five years in from now. So 65 years old, it would be a 65% fixed income mix like it was in other scenario. We've increased that.

So we're at 70% fixed income. Then when we get out to here to 2034, they are 70 years old. And 2034, we still have 70% roughly allocated to our fixed income.

If we fast forward and we go out 20 years from now, so 20 years from now, 2044, they're 80 years old in 2044. 80 years old in 2044. And how much do we have allocated to fixed income? 40%.

So we hit a plateau 15 years into retirement and we kept that balance instead of continuing to ratchet up our fixed income. Now we just flatlined it. We said we're going to stay at 40% fixed income because that meets their risk tolerance goals for the rest of their life.

There's no reason for us to continue to increase how much we're allocating to fixed income or bonds or more conservative allocation because they have $1.2 million already in that bucket. And that's more than enough to handle any sequence of returns risk they may get hit with at that point or later down the line in their 80s, their 90s, or even beyond that. They are now, instead of running out of money in those late 90s, like they would have in the other scenario, now they're still sitting on about $2.5 million.

So this has allowed them to preserve their principle over time rather than spending down that principle over time and over allocating to fixed income. They actually were able to preserve their principle because they didn't over allocate to a lower yielding instrument. This is why you have to leverage the latest in research and really think about how you're building that portfolio.

If you want our team to run for you an analysis like this and provide you a free retirement income analysis, all you have to do is call the number on your screen to schedule a time to have a visit with one of our fiduciary financial planners. No matter where you are in the country, we'll visit with you online.