You have retirement savings. It’s enough to last a while but you’re not sure about it lasting your life time. How do you manage it to provide current income and not run out too soon? This is a big challenge for money managers. If you are working with a financial adviser, thinking about working with an adviser or you’re a do-it-yourselfer, this article is for you as you prepare to navigate the rough waters ahead. If I were speaking as your adviser, here are some of the issues we would discuss.
Your Strategy. Your portfolio requires a balance between the proper mix of savings and investments to create income and growth. Your money will require fairly regular oversight and management. It will probably require the use of multiple savings and investment vehicles. The ‘savings’ aspect will generally include products that protect principal and provide some return usually in the form of interest payments. The ‘investment’ aspect will involve fluctuations in the principal amount as we try to capture some growth to increase the portfolio’s longevity. There may even be an insurance aspect to the portfolio mix.
Just knowing what I describe above, you have to ask yourself if you are up to the task or will need help. You need to know what savings, investments and insurance choices are available, why they are used, how they are used, and when to use them.
You will need to monitor the results in your portfolio and the economic environment (public and private sectors) to know when to make necessary changes. Since no one has a crystal ball to glimpse into the future, historical and current knowledge of markets will have to do.
We’ve covered the easy part. Now let’s get into the meat of the matter. What is the proper portfolio balance? How do you determine your balance? How do you achieve the balance?
Portfolio Balance. The perfect portfolio balance would allow you comfortable current income while simultaneously growing the portfolio so you never run out of money. It’s so much easier said than done. For many it comes down to living on less than you wish or running out of money. If you invested well over your working life, your job is easier. As your adviser, I would rather be safe (manage to last a lifetime) than sorry (you go broke).
I can almost guarantee that my definition of ‘safe’ and yours are different. That means we have to come to an agreement on a definition or we’ll be at each other’s throats at some point in our working relationship and you’ll fire me. ‘Safe’ for you probably involves some form of principal protection. ‘Safe’ for me is maximizing the longevity of the portfolio since going broke isn’t an option in my mind. Principal protection as the primary strategy is a dog that won’t hunt in my plans.
Determining Your Balance. Let me start by providing a measuring stick. The following spectrum will help define our portfolio balance situation.
Principal Protection Principal Loss
For illustration, 100% principal protection is a guaranteed savings vehicle like a FDIC insured savings account or CD. 100% principal loss is gambling or over spending.
The potential rub between us is that ‘safe’ for most people usually implies a form of principal protection and as a result people seeking safety prefer the far left side of the line above. When people aren’t sure whether they have enough money to last a retirement, they want to protect the money thinking that will help it last–our minds fear the potential loss more than we crave the potential gains. But the truth about the line above is that both the far left and the far right of the line result in the same outcome; you go broke during your lifetime.
On the left side of the line, you’ll use your principal to live on and burn through it much faster than it can grow to offset your usage rate. This is the classic scenario of outliving your savings. On the right side, you’ll throw your principal away before you die. So essentially an FDIC insured account is the same as gambling when you consider the ultimate long-term outcomes.
For me, safety is somewhere between the dots and that’s where the challenge is between us. I have to coax you to go out onto the line between the dots and that can be a scary place for some retirees. Then I have to determine how far out on the line I need to go with you. I can’t be too safe and I can’t be too aggressive (risky). Three huge factors in this consideration are: how much money do you have, how long I have to make it last, and how much income you need now—not to say there aren’t plenty of other factors.
Achieving the Balance. This is where the recipe gets complicated and can’t be comprehensively explained in this article. However, I want to get you pointed in the right directions in case you want do more research. The balance is a mix of the right savings, investments and insurance products that allow you to withdraw a reasonable amount of income each year and at the same time grow the portfolio to last a lifetime. Here’s where you have to know what the products are, why you use them, how you use them, and when to use them. Having knowledge of the economy and markets is a big plus.
What. The choice of savings or investment products span the cosmos—savings accounts, CDs, bonds, stocks, mutual funds, options, convertible stocks or bonds, closed-end funds, Exchange Traded Funds (ETF), Unit Investment Trusts (UIT), private money managers, annuities, life insurance products, long-term care insurance… This only skims the tops of the trees since each of the items listed have many (hundreds or thousands) branches below the tree top.
Why. Some of the choices above provide for a stable principal, some are for income, some are for growth, and some provide a combination of outcomes. Whatever the expected results are for each of these choices, you can be certain that how each choice delivers its result will involve a pro and a con in relationship with the rest of your portfolio. You should know the pro and con for each choice to offset and balance the results with the other holdings in your portfolio.
When you shop for an adviser, it should be a part of your shopping list to ensure the adviser understands not just what the choices are but also why and how to use them. Know how many choices your adviser offers. Some advisers only offer a few choices. If an adviser offers only a few choices, they will make their choices work for you even if there are other choices in the cosmos that may work better for you.
Also consider all of your various accounts and how what you do in one account balances with what you do in other accounts. If you are working with an adviser, and the adviser is only working with one of your accounts, the adviser may duplicate another account or counteract another account since all accounts might not be visible to the adviser.
How. Once you understand why you use one choice over another (“I need income.”), how you use the choices are dependent on your specific needs and goals. In this case, our desired outcome is generating income, so we may purchase an immediate annuity to generate a steady flow of guaranteed income for life. Or we could purchase dividend paying stocks, or a closed-end fund, or a bond, or an income generating mutual fund or sell covered options…on and on.
If we purchase an immediate annuity, this allows us to consider alternate portfolio choices with your other accounts in the light of having established a guaranteed lifetime income stream with the annuity. Meaning, you may be able to move a little further out on the line with your other accounts to assume some potential for greater growth. Or you may be able to reach for greater income with more aggressive income investment vehicles like junk bonds or closed-end funds.
If you purchase a long-term bond mutual fund for income instead of an immediate annuity, things change for other portfolio choices. Realizing that interest rates are at all-time lows right now, the outlook for bond prices is down in the future. Here’s where the econ and market insights help. Expecting the value of your long-term bond fund to go down in the future (and your account value), how will we offset this issue with other portfolio choices? On the flip side, while your bond fund goes down in value, we can expect the income payments to increase. How does this change other choices in the portfolio? Maybe we don’t have to rely on the other choices to provide as much income so we can focus on making up the loss in value of the bond fund with other growth choices. Usually when bond prices decrease it leads to growth vehicles increasing in value. Maybe we don’t need to bulk up on growth options as much and can bulk up your income producers so you have more spendable income. Choices choices.
When. When to use one choice over another is tough because we can’t predict the future—not even the pros know the future. We can only read articles from respected people in the field, keep tabs on current economic events (not fads), and understand some history about economies and markets. However, don’t focus on current trends as the base line for your decisions. Trends are just that; fleeting events. Tomorrow they will be something else.
That’s why you have to follow the media with a healthy dose of suspicion. The media don’t mention anything until the investment has done something to create a newsflash worthy story, and by that time, it’s too late for investors. Besides all the sales people come out during the periods of euphoria in an investment to take advantage of your need for greed. Have you noticed how firms hustle gold to satisfy greed? Sales people also like periods of crisis because they can play on your fear. Have you noticed how firms hustle gold to alleviate your fear? One investment idea like gold can be spun to push either your greed or fear button. There is always an answer to greed or fear and sales people will find it when something is in the news.
View a bigger picture of society and the world. What are the big economic conditions? Housing in a slump or peeking? Interest rates up or down? Unemployment up or down? Construction on the rise? Consumers in a buying mood or a savings mood? Then remember that these events are temporary. Will the housing slump last forever? Is a down market something to fear or a temporary condition that will come back at some point and represents an opportunity to get on the ground floor of something good? How much time do you have to wait in your portfolio? How can you situate other portfolio choices to offset or balance the choices that will take time to rebound?
Can you prevent the need to deal with all these issues? Sure. If you are a ways from retirement, save and invest to have assets beyond your future needs. If you are close to retirement or retired, you could establish a retired living standard well below your means. You can plan to have no debts and very few other payments going into retirement. You could also choose to live in a lower-cost area. Or if you are retired, consider working at some level to subsidize your income thereby minimizing the need to pull from your assets.
Working in retirement accomplishes several good things. One is that it provides more options for how you manage your retirement assets. You can reduce the withdrawal amount from your assets which allows you to re-allocate your portfolio to capture more growth. Besides the money issue, working keeps you busy, works your mind and provides you a purpose in life. Finally, chances are the spouse could use a break from having you around all the time; no matter how charming you are.
We’ve just scratched the surface of money management and portfolio considerations. In some ways it would be great if the task of money management was a simple recipe that could be easily followed by all with success. That would solve a ton of problems. But in another way, the fact every person’s needs and goals are different and we have an assortment of choices to build a custom plan suited for each person is a good thing. Cookie cutter approaches only work for the people whose financial situations fall within the design of the cookie cutter.