Setting up Your Retirement Portfolio

My previous post titled “Funding Your Retirement” explained how to determine the size of retirement fund needed to ensure your twilight years are financially secure. In this post I will explain the considerations and process involved in putting your retirement (or any) portfolio in place so it can earn returns that build upon the amount you have saved.

Before we set out on the road to investing, I should point out that you have two broad options in terms of how you can use your savings to secure your retirement. One option is to purchase a single premium annuity from an insurance company where you pay them a lump sum amount and they agree to pay you a guaranteed monthly amount for the rest of your life. The monthly annuity received would depend on the lump sum amount paid and is usually based on a guaranteed return of between 3% and 4% per annum. This option may be preferred by someone who wants to eliminate the risk of outliving their savings. With the annuity option however, payments cease when the annuitant dies, regardless of how many monthly payments were made. While insurance companies do offer annuities that are guaranteed for a minimum period, the monthly income is lower for a guaranteed annuity.

The second option is to invest your savings and use withdrawals from the investment portfolio to fund your retirement. Many prefer this approach for several reasons including the ability to utilize their funds to meet special needs that may arise, to benefit from higher investment returns, and there is also the possibility of leaving assets for their heirs. This post will focus on the process involved if you choose the investing route.

The simple answer to the question of “when should you start investing?” is “as soon as you start saving”. By investing we mean using your savings to purchase assets that will bring you a higher return than what you currently earn (which would be nothing if it is sitting in a bank account). Investing is not a one-size-fits-all approach but rather, the assets you invest in would depend on factors such as your risk tolerance (i.e. the ability to stomach the ups and downs of markets), investment horizon, the amount saved relative to your needs, your investment objectives as well as the level of planned withdrawals from the portfolio. Given the nuances involved, you will need to consider whether you have the knowledge and experience, as well as the desire, to retain responsibility for managing your investments, or if you should utilize the services of a financial advisor or an asset manager. Regardless of whether you manage the process yourself or use an expert, you still need to be acquainted with some of the basics of how investing works.

To simplify the process of investing we group investment assets with similar characteristics into what we refer to as asset classes. The main broad asset classes are cash, stocks or equities, bonds or fixed income and alternative assets such as real estate, commodities and private equity. These broad categories may be further sub-divided using criteria such as currencies, geography and structure (such as single security, mutual funds, exchange-traded funds, etc.). As you contemplate what assets to add to your investment portfolio, you should use these asset classes as a guide.

The first step in setting up an investment portfolio is to develop a strategic asset allocation. This simply means deciding how much of the portfolio will be invested in each asset class. This is an important step as studies have shown that asset allocation is responsible for up to 90% of an investment portfolio’s return over the long term. The balance of returns is determined by market timing, in terms of when you buy or sell, and individual security selection. A simple strategic asset allocation would look something like the following:


Asset Class Strategic Allocation Tactical Allocation
Cash 5% 5% – 10%
Bonds 40% 30% – 50%
Stocks 45% 40% – 60%
Alternative Assets 10% 0% – 15%
Total 100%  


The strategic allocation represents the long-term target, while the tactical allocation is the range within which the actual allocation can vary based on market conditions and other circumstances. This strategic asset allocation is informed by an evaluation of the investor, taking into account the following factors:

  • Risk tolerance. To determine the type of investments that are appropriate for your portfolio you will have to gauge your risk tolerance, that is, the amount of volatility you are able and willing to accept in your portfolio. Risk tolerance can be assessed based on your responses to a series of questions on investing and is usually categorized as low, medium and high, or alternatively, conservative, moderate and aggressive. You can determine your risk tolerance using KSBM’s Risk Tolerance Questionnaire.Gauging your risk tolerance is key in the decision of setting up your portfolio as there is a correlation between return and risk where, historically, the potential for greater returns has been accompanied by greater risk, with the possibility for reduced or even negative returns. Risk in this context refers to the volatility of returns, both positive and negative, where return is measured as the change in the value of the investment portfolio. Higher risk investments experience greater fluctuations in value but also earn higher returns, on average. Cash is at the lowest end of the risk spectrum, bonds are higher risk than cash, stocks are higher risk than bonds and alternative assets have the highest risk of the asset classes. Therefore, an investor with low risk tolerance should have more cash and bonds in their portfolio, while an investor with high risk tolerance can have more equity and alternative assets in their portfolio.
  • Investment horizon. This refers to the length of time the investor expects to maintain the investment portfolio. A retirement portfolio is intended to remain in place over the life of the investor so the length of the investment horizon would depend on current age and life expectancy. Generally, the longer the investment horizon, the greater the level of risk the investor can take as they can hold investments through the ups and downs of the market. Someone with a short investment horizon who invests in a more volatile asset, such as stocks, may be forced to sell at a time when the price is down, resulting in realized losses. Consequently, persons with a long period before retirement can adopt a more aggressive investment strategy but as they approach and then enter retirement, their strategy becomes gradually more conservative. For example, someone less than 40 years old could have between 80% and 100% of their portfolio in stocks while a person aged 60-65 could have between 45% and 60% in stocks.
  • Investment objectives. This includes target return as well as planned withdrawals from the portfolio. The level of return desired would dictate the type of securities held where a greater proportion of stocks and alternative assets would be required to generate a higher return. Also, assets vary in their liquidity and income generation, so it would be necessary to hold cash and bonds to satisfy withdrawal requirements in the short to medium term.

Moreover, the strategic asset allocation for a retirement portfolio would typically consist of a mix of bonds and stocks with small allocations to cash and alternative assets. Bonds are less volatile than stocks, generate income for the portfolio and are held for capital preservation as the principal value of a bond is repaid on maturity. Stocks on the other hand have the potential for capital appreciation and can contribute to portfolio growth.

Once you have your investment plan with strategic asset allocation in hand, the next step is to set up your investment account to hold the assets you will be putting in your portfolio. If you use an asset manager, they will handle all of this for you, but if you are managing your own portfolio you will have to set up accounts with the relevant institutions. To invest in stocks you will need an equity brokerage account which you can open with a stockbroker. Bonds, on the other hand, trade over-the-counter so you will need to establish a relationship with a broker who has access to bonds and provides custodial services.

At this point you are either ready to start buying assets for your portfolio or you have left it in the hands of your investment manager. Either way, you need to understand the considerations involved in selecting investments and in monitoring those assets in your portfolio. In subsequent posts we will do a deep dive into investing in stocks, bonds and other asset classes.


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