Welcome to the ‘Understanding Retirement Planning & Investing’ series! If you’ve missed the first few posts be sure to check them out!
As a financial advisor and somebody that regularly helps people plan and transition into retirement, it’s quite difficult to get people to understand that the way you should be invested during retirement is different than the way you should be invested when you’re young!
Last week I touched on Asset Allocation and helped you to understand that a certain percentage of your retirement assets should be tied to stocks, bonds, and cash.
The percentage that is tied to each depends on your risk tolerance but ultimately it should depend on what stage of investing you’re in.
1. Accumulation Stage
This stage of investing is pretty straight forward: it’s the time of your life that you’re accumulating assets.
It’s the stage that 95% of advisors talk about and it’s the stage the majority of advisors know how to handle.
This stage of investing has a few important components:
Knowing that your biggest concern is outpacing inflation during your accumulation years, you should have an asset allocation that matches that concern.
Despite what most people think right now because of all of the fear mongering, STOCKS have been the best way to outpace inflation over the last 70 years. With that said, investments such as real estate, gold, and bonds have also had periods of time that they outpace inflation (or at least keep up with it).
So, despite whatever your emotions tell you to do, and even though you may be so tied to your money that you’re afraid to lose any of it in the market, you should have a more aggressive portfolio allocation. Meaning, you should be more heavily tied to stocks than bonds or any other asset class.
Something along the lines of a 75/25 or higher allocation may be appropriate depending on the situation.
If you have no idea where your asset allocation should be, I was informed of this pretty awesome calculator that helps you determine Asset Allocation: 401k Allocation Calculator.
This has really been a new phase of investing that was added in the last 10 years or so and it’s one that many people have difficulty grasping.
Considering it’s not widely discussed and people aren’t aware of the different opportunities to help in this phase, it’s difficult for people that have been accumulating for 20-30 years to change their mindset and focus on more important things such as:
Ideally, if you’ve built up enough assets during your accumulation years, you can transition to the preservation phase approximately 10 years before you plan to retire.
However, some people won’t be able to start preserving assets until 5 years prior to retirement, and the majority of people may never have this luxury as they’re doing all they can to chase returns since they didn’t save properly from the beginning.
A few co-workers and I have shared stories about parents or grandparents that fell victim to stock market crashes and it always reminds me of a person I knew quite a few years back…
He had been working his whole life and actually had done a pretty good job with accumulating assets. He was in his mid-50s and he planned to retire in 3-4 years (this was back in 2007).
Well, having the mindset of most people this person was stuck in the accumulation phase and when 2008 hit they lost quite a large sum of their retirement savings.
Needless to say but that person is still working today.
The preservation stage basically says ‘I can’t afford to lose any of the money that I’ve spent years saving, but I also need it to earn a little more than what the traditional “safe money” options would offer.’
This is a hard stage for boomers and seniors to grasp, but it’s important to change the mindset or you’ll run the risk of working far past what you anticipate – especially if things take another turn for the worse.
Think about it for a second, if you’re on pace to retire when you WANT and you’re getting within a few years of that date, why chase returns while taking on unnecessary risk? What’s the point?? There is a fine line between being a wise investor and being greedy.
One of the biggest mistakes we see is that people take on too much risk when they don’t have to, and the people that need the high returns aren’t taking on enough.
While there isn’t a perfect asset allocation for the preservation phase of investing, common sense would suggest that you scale back your allocation to a more moderate approach (maybe 50/50 or less depending on how you feel about bonds in this low-interest rate environment). More importantly, depending on the person and their situation, insurance products such as annuities may offer guaranteed returns with ZERO market risk.
Just like there are asset classes that outpace inflation better than others (primarily stocks and sometimes bonds, gold, and real estate), there are asset classes that are better suited for the distribution phase of life.
The distribution phase of investing is when you’ve stopped working and now rely on your assets to provide an income stream (ideally one that you cannot outlive).
As a retiree, there are really only a few ways that you can create an income from assets:
I’m often amazed at how many people choose the last option. Frankly, it scares the BAJESUS out of me! The reason it scares me is the biggest risk in the distribution phase of investing is outliving your assets.
The people that typically resort to drawing down a percentage of their assets are still stuck in the accumulation mindset and haven’t realized (or been educated) that there are better ways to draw income. Think about it for a moment, if you have $1,000,000 saved for retirement and are drawing down 5% ($50,000/year) to live off of. What happens if the market tanks 40% and now you’re only pulling in $30,000? Not to mention, that $30k you just pulled from your ever-depleting $570k nest egg will get lower and lower each year unless the market bounces back significantly!
Each situation is different and there are pros and cons to each option, regardless of which phase you’re in. The solution typically lies where the person is most comfortable operating and more often than not it’s determined by what jargon they’ve been fed their entire lives.
The important thing to remember is that your mindset must change as time goes a long. If you’re unwilling to change or fail to accept a different investment approach based on your phase of investing, then you may run into serious problems down the road (well, unless of course you’re just rolling around in dough).
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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