If you are retired, chances are that you have heard from a friend, or perhaps even said to yourself one of the following…
“We lost so much in 2008. I didn’t think I was taking that much risk with my portfolio.”
“I’m not sure I can afford it, since we were hit so hard when the market dropped.”
“I bought an investment without understanding all of the details, and now I’m having trouble getting anyone to explain it to me.”
The question is, “Where do you go from here?” And you’ve no doubt read or heard about a silver bullet type investment that promises the moon without any risk. If you’re looking for that silver bullet, you won’t find it here. But if you’re serious about getting back on track, here’s what you need to do.
1. Avoid some common mistakes
2. Develop a realistic income plan for your investments
3. Transition from a “collection of securities” to a “purpose built portfolio”
4. Find a source of ongoing, competent advice aligned with your best interests
Mistakes to Avoid
Don’t overspend and deplete savings early. In the absence of a formal retirement distribution plan, a simple rule of thumb is to access no more than 4% a year from your investments to make sure you won’t outlive your savings.
Don’t invest too aggressively. When a person goes from building savings to accessing income in retirement, their portfolio should become fairly conservative. That’s because a severe market decline, like 2008, can permanently compromise a retiree financially.
Don’t overlook health care costs. The healthcare landscape may be changing in America, but it is unlikely to become any less expensive. Several examples are retiring early without a plan to bridge the gap until Medicare eligibility at 65, not accounting for supplemental insurance needs beyond Medicare coverage, and the likelihood of requiring eventual nursing care. Accounting for these costs should be part of every retiree’s target budget.
Develop a Realistic Income Plan
How much income can you reasonably expect from your investments? Retirement projections are number crunching exercises that stress test your portfolio to show the effects of longevity, inflation, taxes, and investment performance. The result should indicate how much income you can count on from your portfolio, in bull and bear markets. Be aware of assumptions that seem overly optimistic, like aggressive investment returns or unrealistic inflation and tax rates.
Once you’ve fine tuned your income plan so that your cash flow needs match your portfolio’s ability to generate income, you should determine what investment profile achieves this for the least amount of risk. At LeConte, we spend a lot of time talking about the difference between a “collection of securities” and a “purpose built portfolio”. Where the “purpose” is retirement income, the investments should be allocated to take as little risk as necessary to ensure not just that it meets your income needs now, but that it will continue to do so for the rest of your life.
Last, how do you access your investments for income? This final piece involves the logistics of creating your retirement paycheck. It determines when and from which accounts to take money, and should also address tax ramifications. This should be projected out five years at a time so that external changes in the market, tax laws, etc. can be anticipated and accounted for without disrupting your lifestyle.
From a “Collection of Securities” to a “Purpose Built Portfolio”
In getting acquainted with new clients, we often ask them to tell us about their investment strategy. This typically leads to a discussion of the reasons behind what they own in their portfolio, like, “Well I bought this because my money market wasn’t making any money, and it had an attractive rate,” or “My broker sold me this because he said we needed exposure to foreign stocks,” or “After our accounts went down so much I wanted something with a guarantee.” All legitimate reasons to purchase a security, but they still do not answer what the overall strategy is.
It’s the “forest and trees” argument. It’s hard to know if you’re investing properly if you aren’t taking a comprehensive view of your investments. The difference is having a unified purpose that addresses diversification on three levels;
1. The balance between equities and fixed income holdings, derived from the investor profile in your income plan
2. Which asset classes (i.e. large cap stock, government bonds, etc.) to use and to what extent
3. What specific holdings to use in fulfilling that allocation (mutual funds, ETF’s, individual bonds, etc.)
In constructing your purpose built portfolio, you and your advisor should be able to look at every holding and justify how it supports your retirement income. For example, a short term, fixed income holding may be a cost effective way of positioning capital for liquidity in twelve to eighteen months, so that you can take advantage of rising interest rates after they’ve risen by purchasing securities with higher yields. Or an international equity holding may provide diversified global exposure to compliment that of domestic equity holdings, all pursued to combat the eventual effects of inflation on the income your portfolio creates.
And equally important as allocation and security selection is ongoing monitoring. “Buy low sell high. Pigs get fat, hogs get slaughtered. The difference between the amateurs and the pros, is that the pros know when to sell…” You’ve heard the aphorisms, but the point is, investing is more than a roadmap, it’s a journey, so you need to establish a source of advice that can help you stay on track.
If cynicism were a stock, it would be the best performing security of all time, especially given the recent performance of politicians, Wall Street executives, and the media. So if the blunt reality is that everyone has a vested interest, how do you find a source of advice that is aligned with your best interest?
To begin, it’s probably unfair to criticize insurance salesman or stock brokers for selling people investments they neither need nor understand. It is unrealistic to rely on financial sales people for advice. They are not compensated to give you advice. They are often compensated solely to sell financial products.
But it is unfair for someone to sell you something, collect a commission, and disappear into the woodwork, when they’ve generated an expectation that you’ll receive ongoing investment guidance. If your advisor adheres to a fiduciary standard, they are required to act in your best interest, and should
1. Clearly explain how all of your holdings relate back to your overall retirement income goal.
2. Provide you with comprehensive performance reporting to include comparative analysis of the equity and fixed income markets, so you can see how your accounts are faring versus the broader markets.
3. Align their compensation with their responsibility to provide ongoing investment management and financial advice.
In other words, if your retirement nest egg is in the hen house, you don’t hire a fox to protect it.
The Questions You Should Really be Asking
So if your question is, “Where do I go from here,” you know that you should really be asking:
“What should I really be spending based upon what my investments will support?”
“How should I be investing to make sure I don’t outlive my money?”
“Where am I going to get ongoing competent advice to keep my portfolio on track?”