Retirement may signal an end to the daily grind of punching a clock, but from a financial planning perspective it also marks the beginning of some heavy lifting.
The decisions you make with your portfolio during the early years of retirement set the stage for whether your savings will be sufficient to maintain a comfortable lifestyle. (Read more: Tips on savings.)
"Those first few years are very important," said Steven Sass, program director for the Center for Retirement Research at Boston College. "Certain options that you have early on evaporate in later years, and there are certainly risks that you have to watch out for during those years as well."
Those risks include investing too aggressively, which subjects you to losses, or too conservatively, which ensures your portfolio will not keep pace with inflation, according to Sam Stovall, chief equity strategist at S&P Capital IQ.
Take note baby boomers. Almost half of the those boomers who are 65 and older had retired by 2011, according to a MetLife Mature Market Institute survey. Of those still working, more than one third said they anticipated retiring within the coming year, when they turned 66 and were eligible for full Social Security benefits.*
Bucket Portfolio Management
To ensure they don't outlive their savings, the newly retired should allocate their portfolios into age-based buckets that generate predictable income, mitigate risk and invest for long-term growth, said Christine Benz, director of personal finance for Chicago-based mutual fund tracker Morningstar.
The first bucket, aimed at covering living expenses for the first one to two years, should be set aside in a liquid accounts, she said, including money market funds, certificates of deposit and high quality short term bond funds, such as the PIMCO Enhanced Short Maturity Strategy ETF fund, which is not yet rated by Morningstar.
Ron Palastro, a certified financial planner in Brooklyn, N.Y., is also a proponent of the bucket system, which he said makes it easier to visualize an appropriate allocation.
He suggests a more conservative tack — setting enough money aside on day one of your retirement to cover your living expenses for the first five years. (Read more: Catching up on savings.)
If those expenses are $10,000 a month, for example, and you've got $5,000 coming in monthly from pensions, Social Security, or other sources of income, you'll need to set aside $300,000 immediately in cash or cash equivalents. ($5,000 X 12 = $60,000 X 5).
"We take the current market environment out of the equation, and we put that first tier of money in a very conservative account that guarantees liquidity, like short-term money market funds or government Treasurys," said Palastro.
While interest rates on immediate annuities are not attractive at present, Palastro does recommend them "when it makes sense."
Annuities are contracts between you and an insurance company that guarantee periodic payments in return for a lump sum investment or series of smaller payments. Annuity payments can start either immediately, or at a future (deferred) date at the investor's choice.
Whether you opt to convert two or five years of your nest egg into near-term income, you'll help to eliminate sleepless nights spent fretting over the markets.
You'll also free the remaining assets in your portfolio to focus on longer-term investment opportunities.
The Intermediate Bucket
To that end, Benz said the second bucket in your portfolio should begin with a source of income that covers your living expenses for up to 10 years. It consists primarily of bonds.
"Given the headwinds that fixed income investments could face over the next decade, it makes sense to look at flexible core bond funds — with the latitude to invest overseas and shorten up their interest rate sensitivity," she said.
For income generation during these years, Palastro also recommends a laddered portfolio of certificates of deposit or short term Treasurys that mature in five years, along with deferred annuities that begin payouts five years after you enter retirement.
Go for Growth
The last bucket in your portfolio, intended for use in the later years, should be filled almost entirely with stocks. Think of it as the engine that drives your portfolio, said Benz.
"These are our long-term investments and we're not using that money right away," said Palastro. "If you need to supplement your savings for any reason, you could always tap those investments and grab some of the gains, but the idea is to leave it and let it grow."
According to Stovall, the old adage that your equity allocation should equal 100 minus your age no longer applies. (For instance, that would be 50 percent if you are 50 years old.) With life expectancies on the rise, he said, a better rule of thumb is to use 110 less your age.
If more than one person has a vested interest in your portfolio, some financial planners suggest using an adjusted age, which takes the average age of, say, you and your spouse and modifies that number in the equation.
Stovall said recent retirees should stick with investments that offer the best of both worlds — low volatility and dividend income.
His picks include S&P 500 Dividend ETF, an ETF that tracks large cap, blue chip companies that have increased their dividend annually for at least 25 consecutive years.
He also likes PowerShares S&P Low Volatility Index ETF , which tracks 100 stocks from the S&P 500 with the lowest trailing 12 month standard deviation — a commonly used measure of volatility.
When the S&P 500 lost 37 percent on total return basis in 2008, the funds were down 22 percent and 21 percent, respectively.
High quality stock exposure is important for stability, but Benz said new retirees should not rule out growth stocks entirely.
"Emphasis on mega cap, high quality dividend payers is a good way to go," she said, noting Vanguard Dividend Growth , a five-star fund, focuses on high-quality names that tend to offer better downside protection than many large-cap equity funds.
Diversify With Discretion
Don't forget to include foreign stocks, such as the Harbor International Fund, and a "dash" of commodities exposure via funds like Harbor Commodity Real Return, said Benz, noting retirees should have no more than 5 percent of their portfolio in commodities due to their volatility.
Commodities, which include raw materials such as wheat, gold, and oil, can help hedge inflation, since the price of those goods typically rises when inflation is accelerating.
You can further hedge inflation by allocating a small percentage of your portfolio to Treasury Inflation Protected Securities, or TIPS, which are government issued bonds.
"TIPS valuations are not as attractive as they were a few years ago, and I think you also have a fair amount of interest rate sensitivity, so for people who want TIPS in their portfolio it makes sense to gradually build into the position rather than putting 30 percent of your bond allocation all in on one day," she said.
The longevity of any portfolio, of course, is hugely dependent on your withdrawal rate.
For most investors, removing no more than 4 percent of their earnings the first year, and adjusting the dollar amount each year thereafter by the rate of inflation is still a good rule of thumb, said Benz.
If you're newly retired or on the cusp of calling it quits, you'll need to revisit your portfolio post haste.
A bucket system that provides for your short- and intermediate-term income needs, while continuing to invest for growth, can help ensure you don't outlive your savings.
n earlier version of this story said that a MetLife Mature Market Institute survey estimated that almost half of all baby boomers were retired. In fact, it is almost half of all boomers 65 years old.*
— Shelley K. Schwartz