My Comments: The basic premise here is accurate, but I have a problem with the author’s tactics. There is an inherent bias among those whose audience is mostly market traders. I understand this bias. I’d likely have it too if I practiced exclusively in that world.
But I don’t live or work in that world. My world is full of folks who consider anything other than a Certificate of Deposit as having too much risk. Not everyone, but enough that it becomes imperative to teach people that it’s not risk that’s bad, it’s the failure to manage the risk that’s bad.
There is a place for stocks and bonds in your retirement portfolio unless you plan to be dead soon. If so, you should try to buy more life insurance with your money. So, these words by Mr. Saletta are simplistic but the overall argument has merit.
By Chuck Saletta | November 06, 2016
As a retiree, you face conflicting priorities for your money. On one hand, you will likely need to take money out of your investments to cover your costs of living. Money you need for near-term expenses does not belong in stocks. On the other hand, the money to take care of your longer-term needs can remain invested in stocks.
After all, costs of living can rise for retirees faster than overall inflation. For instance, healthcare-related costs typically increase faster than overall inflation, and people frequently need more healthcare services as they age. Unless you already have enough saved up to directly cover your (inflation-adjusted) costs of living for the rest of your life, you’ll need money invested in assets like stocks that have the potential to grow.
Balancing stocks and bonds for retirees
Your retirement may very well last 30 years or more. That’s a long time for your investments to have to provide for you, and striking the right balance between stocks and bonds is a critical part of helping your money last as long as your retirement does.
If you put too much in bonds, particularly in today’s low interest rate environment, you risk not having enough long-term returns to cover your costs later in retirement. On the flip side, if you keep too much in stocks, then you risk having to liquidate shares to cover your costs of living when the market is moving against you. Enough of those forced liquidation events could also put you at risk of running out of money before the end of your retirement.
Somewhere in between is the sweet spot. Your goal is to have enough in higher-certainty investments like bonds to cover your near-term costs, and enough in higher growth potential investments like stocks to cover your longer-term needs. To achieve the right balance, you need two things: enough in bonds to cover a market swoon, and enough in stocks to let “normal” market returns replenish your bonds.
How much is enough?
A general guideline among retirement planners is something known as the 4% rule. Under that guideline, if you do all of the following,you have a very strong chance of seeing your money last at least as long as your retirement will:
• Start with a diversified portfolio of stocks and bonds.
• Withdraw 4% of the value of your portfolio in the first year of your retirement.
• Adjust your withdrawals for inflation every year.
• Maintain portfolio diversification throughout your retirement.
The 4% rule means your overall portfolio should have about 25 times the annual living expenses you need it to cover by the time you call it quits. Of that total portfolio, you need at least five years’ worth of expenses in investment-quality bonds, with those bonds selected to mature and convert to cash around the time you need to spend the money. You’ll also want enough cash to cover your immediate expenses, as even short-term bonds can move based on interest rate changes.
For instance, assume you expect to need $50,000 per year to cover your retirement expenses, and you’re anticipating $15,000 per year from Social Security. Since Social Security’s benefits are indexed for inflation, you’ll need your portfolio to cover $35,000 per year of income. By the 4% rule, that would require a portfolio of $875,000. If you assume 3% inflation, your starting portfolio might look something like this:
How to use your stocks in retirement
With a portfolio set up like that, your immediate expected living expense are covered by your cash, and your bonds will become cash at maturity to allow you to cover your future anticipated costs. That covers your near-term needs, but as your bonds mature, they’ll need to be replaced to supply your longer-term future spending needs. That’s a great role for stocks to play in your retirement.
As you own your investments, you should receive interest from your bonds and, potentially, dividends from your stocks. That cash can go toward replenishing the long-dated portion of your bonds as they march toward maturity. In addition, if the stock market cooperates, you can sell a portion of your stocks as they rise in price to also help replenish your bonds.
If the stock market performs incredibly well, you can use the excess gains to extend your bond holdings — instead of five years, perhaps you can extend it up to six, seven, or more. If the stock market suffers a downturn, you don’t need to sell right away to cover your costs thanks to your bonds and cash. Just be sure you do convert enough stocks to bonds as the market recovers over time so that you can keep that combination of flexibility and higher certainty of cash flows throughout your retirement.
Help your money last throughout your retirement
With cash for your immediate needs, bonds for your short- to mid-term future, and stocks for your longer-term future, you set yourself up with a plan that matches your assets to what they do best. That gives you a great leg up on the top financial priority most retirees have: the quest to make your money last as long as your retirement does.
Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.