How to invest your retirement money.
When it comes to investment portfolios, retirees have a much different set of objectives, risk tolerances and time horizons compared to young investors in the accumulation phase. For retirees, ensuring a reliable perpetual withdrawal rate for their income needs is paramount. Ensuring safety of principal is also key, as market corrections and bear markets can pose significant risks to retirees relying on their portfolios for living expenses. A well-diversified portfolio of high-quality stocks and bonds goes a long way to ensuring this, but there are additional tips and tricks to consider that can help you correct unwanted investment biases and behaviors. To help you make the right portfolio management and asset allocation decisions, here are 10 rules for investing after retirement, according to wealth management experts.
Be honest about your expenses.
The easiest way to ensure your nest egg doesn’t run out in retirement is to get an honest appraisal of your spending patterns. “Knowing how much you need to spend will reduce or eliminate the need to make excess withdrawals from your retirement investment portfolio,” says Bill Cannon, director of retirement plan consulting at Wealth Enhancement Group. If markets take a downward turn and your portfolio needs to recover, getting a grip on your spending can prevent you from depleting it when it is most vulnerable. One of the biggest factors in whether your portfolio’s withdrawal rate can be sustained in the long run will be your spending patterns, so keeping this realistic will go a long way toward a sustainable retirement.
Don’t make fear-driven or emotional decisions.
A common mistake for many investors is succumbing to fear, uncertainty and doubt during market downturns. A common example is panic selling during a crash to preserve capital by fleeing into safer money market instruments. This ensures that investors “buy high and sell low,” which destroys portfolio value and can severely harm your retirement. Cannon suggests mitigating this by “filtering out the noise, and not reacting to the news cycle or geopolitical events.” A common suggestion echoed by many passive index investors might apply here: “stay the course.” “Avoid short-term decisions for your long-term retirement income portfolio. You may regret them down the road,” Cannon says.
Aim for tax efficiency.
Retirees holding a portion of their portfolio in taxable accounts should try to optimize their asset allocation for tax efficiency. Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Michigan, notes that “qualified dividends are preferable, as they are taxed at a far more advantageous rate.” These are generally stocks of U.S. companies that pay ordinary cash dividends. When selecting dividend stocks, investors can “focus on dividend growth equities, where the dividends provide much or all of the cash flow necessary,” he says. This approach can help retirees create a tax-advantaged stream of income from assets in taxable accounts. Tax-advantaged accounts can be used to hold less-efficient assets, such as bonds and real estate investment trusts, or REITs.
Ensure your portfolio’s asset allocation is sufficiently diversified.
Retirees should avoid the risk of a single asset, stock, sector or geographical concentration in their portfolios. Professor Michael Collins of Endicott College in Beverly, Massachusetts, recommends “investing in a diversified mix of assets, including stocks, bonds, cash and alternatives.” These assets have varying degrees of correlation, which reduces the risk of drawing them all down simultaneously, which reduces portfolio volatility. He suggests reviewing and rebalancing your asset allocation on at least an annual basis to ensure it is “appropriate for your risk tolerance and time horizon.” This means selling assets that have outperformed and buying ones that have underperformed to bring your asset allocation back to the target proportions.
Don’t write off annuities.
Robert Johnson, finance professor at Creighton University in Omaha, Nebraska, advocates for annuitizing some income. “The greatest fear of retirees and near-retirees is running out of money in retirement,” he says. Johnson believes that “annuities are an important part of a comprehensive retirement plan, as they can provide guaranteed income and peace of mind.” Milan agrees. “Income-based annuities should be considered both as a foundation to your income stream along with Social Security and possibly as a replacement for traditional fixed income.” A way to go about this is by purchasing an annuity that covers your basic living expenses.
Mitigate sequence-of-returns risk.
Sequence-of-returns risk refers to the possibility that retirees will experience a series of large drawdowns or market corrections during the critical period just prior to their retirement. Johnson calls this the “retirement red zone,” stating: “A large downturn in the equity markets immediately preceding retirement can have devastating effects on an individual’s standard of living in retirement.” To mitigate this, retirees should consider reducing risk exposure (often by substituting high-quality Treasury bonds for equities) before retiring. This doesn’t eliminate risk completely though. “At retirement, some retirees still have a time horizon in excess of 25 years,” Johnson says.
Hold a sufficient cash reserve.
Cash is the ultimate protection in a market downturn. While it loses value to inflation, during a bear market cash keeps its value. Keeping a healthy allocation to cash in your retirement portfolio can help provide a reserve to draw on if other assets fall. Jamie Ebersole, founder & CEO of Ebersole Financial in Wellesley Hills, Massachusetts, suggests to “hold one-to-three years of living expenses in a cash runway.” “This helps avoid excess or surprise withdrawals that could be costly when your portfolio values are down,” Ebersole says. Investors can hold cash in their brokerage accounts, or purchase money market securities like Treasury bills, or T-Bills, and certificates of deposit, or CDs.
Consider hiring a professional money manager.
Retirees with a large portfolio and estate can consider having their finances professionally managed. An accredited wealth management professional can offer a variety of services, from tax and estate planning to investment selection and allocation. The biggest mistakes that many investors make is often behavioral, and a good financial professional can help prevent those, as well as navigate any regulatory intricacies. John Lau, president and CEO at LFS Wealth Advisors in Burlingame, California, suggests working with both a certified financial planner, or CFP, and a certified professional accountant, or CPA, for a comprehensive approach to retirement planning. In his view, retirement goes beyond just investing, and requires a degree of “strategic financial planning,” which could be helped by expert advising.
Hold enough in stocks.
A mistake many retirees make is holding too low of an allocation to stocks. While stocks are volatile, they also drive most of a portfolio’s returns. A retirement portfolio with insufficient stocks runs a significant risk of being depleted too early. “When you retire, you will likely need your assets to work for you for another 20 to 30 years. To keep up with inflation and stretch your assets, you will still need a significant allocation to stocks,” Ebersole says. While holding stocks creates risk because of their volatility, not having enough creates the even larger risk of running out of money too soon. Your stock allocation should be matched to your investment objectives and time horizon first, and then adjusted for your risk tolerance.
Manage your estate.
Unfortunately, the golden years of retirement don’t last forever. Sooner or later everyone passes on. Before it’s too late, retirees should consider getting their affairs in order, particularly when it comes to estates and inheritances. Consider writing a will and designating beneficiaries, trustees and executors for once you pass away. Ebersole suggests “gifting assets selectively to reduce your estate before it’s too late.” Examples of this include gifting appreciated stock to charities, funding 529 plans, or paying medical and educational expenses directly for family members. Ebersole notes that these strategies are “a great way to reduce your taxable estate without endangering your financial health.”
10 rules for investing after retirement:
— Be honest about your expenses.
— Don’t make fear-driven or emotional decisions.
— Aim for tax-efficiency.
— Ensure your portfolio’s asset allocation is sufficiently diversified.
— Don’t write off annuities.
— Mitigate sequence-of-returns risk.
— Hold a sufficient cash reserve.
— Consider hiring a professional money manager.
— Hold enough in stocks.
— Manage your estate.
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Update 06/15/22: This story was published at an earlier date and has been updated with new information.