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While conservative investing may sound good from a peace of mind standpoint, it can be one the riskiest things that you can do when it comes to distribution planning. Conservative investing is typically associated with low volatile investments that are relatively safe, predictable, and even guaranteed, in limited circumstances, when it comes to rate of return. However, with all things being equal, lower volatility will most likely lead to lower returns for your portfolio.
The right amount of risk varies from person to person, and it is important to strike the right balance. But the fact of the matter is, inflation and cost of living increases are inevitable over a 30 to 40-year retirement, and you must consider holding investments that can “keep up” or better yet outpace inflation in order to preserve purchasing power. Historically, a potential solution to this has been allocating a portion of the portfolio to equity investing.
We advise retiree clients to keep a “safety net” of at least of 7 years’ worth of retirement income, which is made up of cash, fixed-income investments, and/or cash-value inside of a life whole life insurance contract (all of which are deemed to be “conservative” when it comes to risk tolerance).
For example, if a retired couple needs to take $50k/year from their portfolio (to supplement income received from Social Security, pensions, etc.) to meet living expenses, they should have a minimum of $350k set aside in conservative investments to help ensure retirement income is accounted for and ready to access when needed. The remainder of their portfolio can then be invested in potentially growth-oriented vehicles (equities) with the goal of beating inflation to better ensure purchasing power is maintained throughout retirement.
Ignoring inflation goes hand-in-hand with being too conservative. Inflation affects retirement planning in 2 major ways:
Not accounting for inflation (or ignoring inflation entirely) could result in underestimating how much money is truly needed in order to retire. For example, when it comes to erosion of purchasing power, having $100k today would be worth about $54k in 20 years assuming a 3% annual inflation rate. If we look at increasing prices, something that costs $100k today would cost about $180k 20 years from now assuming the same 3% annual inflation rate.
In addition to reducing purchasing power and increasing prices, inflation also affects the true rate of return realized on investments. Below is a summary of hypothetical “before and after” returns accounting for 3% inflation for 10 years:
| Asset Class | Before Inflation | After Inflation |
| Stocks | 12.60% | 9.30% |
| 60/40 Portfolio | 8.10% | 4.90% |
| Bonds | 1.10% | -1.90% |
| Bank CDs | 1.40% | -1.50% |
| Cash | 0.80% | -2.20% |
While it may sound counterintuitive, underspending is a mistake that we often see with many retiree clients. It is often said that the best savers are the worst spenders, so it is natural to be hesitant to pull from a portfolio that took many years and lots of discipline to accumulate.
An exercise that we walk many clients through is to rank their goals on a scale of 1 – 10 (in terms of priority and importance). For example, 2 common questions are:
These are 2 very common conflicting goals that can make retirement distribution planning a challenging endeavor. For example, if a client ranks question #1 as a 10/10, this means that they are placing high priority on spending as much as they can to maximize planning for themselves, vs question #2 where the priority is to underspend to therefore preserve their portfolio and maximize inheritance for beneficiaries.
We often see that retiree clients will say that their own lifestyle is 10/10 importance, but they are underspending relative to what they could withdraw from their portfolio (with limited risk of running out of money). In this scenario, although the client is saying that their own lifestyle is top priority, their actions are putting them on track to leave a sizeable legacy leftover for beneficiaries.
It is important to have a well-rounded asset mix to help reduce risk in distribution planning. This is most commonly achieved through asset allocation, which refers to the act of investing in different categories of investments (asset classes).
For example, a portfolio may hold an assortment of mutual funds, ETFs, stocks, etc. which may make it “feel” like you are diversified since money is spread out across several different holdings. But, in order to be properly diversified, it is necessary to take this one step further and ensure the funds within the portfolio do not have a strong correlation to one another. High correlation tends to cause the entire portfolio to either go up all at once, or down all at once.
It is especially crucial during distribution planning to avoid having “all of your eggs in one basket” because the portfolio’s job during retirement is to provide retirement income on top of things like Social Security, pensions, and annuities. If the portfolio is highly correlated to one index (for example the S&P 500) your retirement income is dependent on the performance of just one piece of the world’s economy.
In order to be properly diversified, a well-rounded portfolio should, for instance, have exposure to US markets, international markets, and fixed income (just to name a few common examples). This allows someone in the distribution phase of planning to “pick and choose” where retirement dollars are coming from. For example, if US markets are performing very well and international is not, it would most likely make sense to harvest gains and sell out of the US holding for the next distribution.
It is tempting to try and time the market. If done successfully, this can lead to big gains in your portfolio, but independent studies have shown that this is very difficult to do on a consistent basis over the life of a portfolio. The reality is, whether you are in your working years or retirement years, you will see several downturns over the life of your portfolio. Rather than selling out of the market altogether during downwards volatility, it is important to stick to a sound investment philosophy and stay disciplined to help ensure your finances (and your portfolio) are working for you and supporting your life by design. If you have a sound investment mix and financial plan, you should not have to live life based on what the market is doing (or isn’t doing for that matter).
In order to time the market, you have to be right twice-
It is especially important for retirees specifically to avoid the urge to “do something” when markets are turbulent. Mistakes during distribution years can be costly and very difficult to recover from.
At EWA, we implement investment strategies for clients to help ensure that money is potentially available regardless of market conditions. As mentioned above (under point #1 “Being Too Conservative), keeping a 7 year back up as a “safety net” is part of this strategy, as well as having a well-rounded asset mix within your portfolio. If the right mechanisms are in place, you can increase your odds of making withdrawals at a gain and decrease the urge to make sudden portfolio moves based on short-term market movement.
Here is a video resource from EWA describing the benefits of long-term investing: https://vimeo.com/manage/videos/658692896
Additional information on EWA’s investment philosophy can be found here: https://ewa-llc.com/blog/principles-to-follow-for-maximizing-your-investment-strategy/
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Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.
Stock markets are volatile, and the prices of equity securities fluctuate based on changes in a company’s financial condition and overall market and economic conditions. Although common stocks have historically generated higher average total returns than fixed-income securities over the long-term, common stocks also have experienced significantly more volatility in those returns and, in certain periods, have significantly underperformed relative to fixed-income securities. An adverse event, such as an unfavorable earnings report, may depress the value of a particular common stock held by the Fund. A common stock may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. For dividend-paying stocks, dividends are not guaranteed and may decrease without notice.
Past performance is no guarantee of future results. The change in investment value reflects the appreciation or depreciation due to price changes, plus any distributions and income earned during the report period, less any transaction costs, sales charges, or fees. Gain/loss and holding period information may not reflect adjustments required for tax reporting purposes. You should verify such information when calculating reportable gain or loss.
This content has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment advice or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document. The tax and estate planning information provided is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
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* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stock of companies maintained and reviewed by the editors of The Wall Street Journal.
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* International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
* There is no guarantee a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
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EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.