I'm currently weighing the Vanguard Target Retirement 2040 vs. doing a mix of Vanguard's International, US, and bond index funds on my own. I don't LOVE the 2040's allocations, but it has one huge advantage: I don't have to worry about the strategies of re-allocating my risk categories as I get towards retirement. As I imagine going from ~30% bond exposure today to perhaps 60% in the future, I have NO IDEA how to make that happen. If I sell off stock funds to invest in bond funds, that's a taxable event, complicated, etc. Any guidance on the move to re-allocate as retirement approaches?


I almost envy you a little bit that you have the option to use a Target Retirement fund.  Between more than a dozen different accounts, many of which don't offer Vanguard TR accounts, there's just no way for me to use such a simple investing solution.  Mike Piper, however, has as his only retirement holding one of Vanguard's Life Strategy funds, which are very similar to the target retirement funds (they just don't change asset allocation as the years go by.)  Target Retirement funds are a great solution for someone who only has tax-protected accounts when each account allows you to purchase the Target Retirement fund.  The rest of us have to build our own.  Remember also that rebalancing isn't that big of a deal, as long as you do so inside your tax-protected accounts.  Even if you have a significant taxable account, you can probably rebalance inside your 401Ks/IRAs without being forced to take a taxable gain to do so.

Nobody Knows The Right Answer

There is very little science out there to rely on when deciding how to re-allocate as the years go by.  The general consensus is that you should take on less market risk as you near retirement and as your nest egg approaches critical mass (i.e. that level at which it can produce sufficient income for you to live on the rest of your life.)  You should also pay careful attention to your own personal risk tolerance.  You never want to take on more risk than you can sleep with, and unfortunately, it is often tough to figure out how much that is until you are in the depths of a bear market.

The Mechanical Approach

Some people prefer a completely mechanical approach to the adjustment.  When they start investing at age 25, they decide they're going to hold their “age in bonds” so they have a portfolio of 75/25 and each year change the allocation by 1%.  After 5 years it's 70/30, after 30 it's 45/55.  Other choose “age minus 10” or even “age minus 20” for their allocation.  You can also choose a mechanical approach that isn't based on your age, but rather on your assets. For example, for each 10% of your “nest egg critical mass” that you hit, you reduce your allocation by say 5%.  So you first start out at 80/20, then when you get to half of your “number” you are at 55/45 and when you hit your “number” you're 30/70.

Tactical Allocation Changes

You can also engage in some more tactical changes in asset allocation, although this requires you to engage in at least a little bit of market timing.  It seems like it might not be very wise to reduce your allocation in years that the stock market does poorly, and to reduce it by more than 1% in years that the stock market does well.  There is also no reason that you have to do this gradually.  You can do it in steps, particularly after you've been in a bull market for a few years.  For example, at the end of 2008 you might decide you don't want to reduce your allocation at all.  Then, at the end of 2012, you might want to go from 70/30 to 60/40 all at once.

Not An Issue Yet For Me

Personally, I set up my asset allocation in 2004 as 75/25 and haven't changed it since.  I've been through at least one big bear market and was able to stay the course just fine, so I know I can handle significant market losses emotionally.  I'll probably make a significant change when my portfolio hits 7 figures (about half my number), but don't anticipate making any changes until then.

What do you think?  How do you plan to reduce your portfolio's risk as you approach retirement?  Comment below!