The ways you invest and save changes over time—they’re certainly different at age 35 than at age 60. A smart retirement savings and investment strategy takes those changes into account. This outlook, which can be called life-cycle finance, names distinct phases of life and the different tactics for managing investments and cash on hand in those phases.
Michael Taylor, Investment Strategy Analyst at Wells Fargo Investment Institute, advises clients to see their financial life divided into three main phases: accumulation, preservation, and distribution. Here, he shares the differences, and the benefits of understanding them.
Saving for Retirement Phase: Accumulation
The accumulation phase encompasses most of your working life. It’s typically the longest of the three phases and can last 30 years or more. During this phase, investing consistently helps improve the effectiveness of your strategy because investors have a longer time horizon to pursue their investment goals. Some key points for this phase:
- Think long term. “I don’t think this is the time for checking the status of your investments several times a day,” Taylor says. “The markets will go up and down, but don’t lose sleep over it.” Instead, commit to a deliberate investing method and stick with it. “Compounding your returns by reinvesting them can be such a powerful tool,” Taylor adds. “Make every effort to take advantage of it.”
- Diversify your investments. Taylor recommends using a mix of four asset classes, depending on how comfortable you are with risk. Categories may include stocks, bonds, real assets (such as real estate, real estate investment trusts [REITs], and commodities), and for certain investors, alternative investments may also be appropriate.
- Get a professional’s opinion. Taylor recommends revisiting your investment plan on a regular basis.. “You may want to adjust your investment strategy depending on your situation,” he says, “particularly in light of heavy expenses, like when children go to college and you’re paying off a mortgage … or recovering from a job loss.”
- Build an emergency fund. During this time, you should keep three to six months of income in cash or liquid assets to make sure you can address urgent financial needs as they emerge.
Saving for Retirement Phase: Preservation
The preservation phase begins three to five years before retirement. “At this point, investors may want to reduce their risk of losing money built up in their nests,” says Taylor. Therefore, many investors consider shifting funds into less-risky investment vehicles. Two additional considerations for this phase:
- Keep an eye on growth. This is a bit of a balancing act between investment stability and risk. To help with this, Taylor suggests that investors consider making a gradual transition to less-risky investments over the course of a few years. “You still want room to seek growth,” Taylor says, “so consider keeping some money in more growth-oriented asset classes, too.”
- Stay focused on your emergency fund. The amount of cash you have on hand is much the same as it was during the accumulation phase. That said, this transition period is the time to think through how this fund might change during retirement (more on that below).
Saving for Retirement Phase: Distribution
The distribution phase starts when you stop full-time work. At this point, you may want to increase your allocation to more stable investment vehicles, those that are typically less susceptible to market volatility. Keep in mind, though, that your retirement could last two or three decades, so consider maintaining some exposure to growth assets like equities. Key considerations for this phase.
- Know your drawdown strategy. One strategy is to keep your investment principal intact and cover all your expenses using interest and dividends. Alternatively, you can take gains in your growth assets to supplement your income. In either case, keep a close eye on expenses so they don’t accelerate wildly and deplete your savings.
- Consider part-time work to cover costs such as healthcare or travel. This is especially helpful if you fear you might outlive your savings. Many retirees are free from mortgages and college tuitions but will see their health-care expenses rise.
- Change your “cash on hand” thinking; in particular, increase your emergency fund. “You’re no longer making a full-time salary, so use expenses as a guide,” Taylor says. His advice: “Plan ahead and set a budget. Keep about a year’s worth of cash reserve to cover foreseeable costs, including planned expenses like vacations.”