Ready For Retirement
Ready For Retirement
What’s the Smartest Investment Mix for Retirees Right Now?
Navigating market volatility in retirement requires more than the traditional 60/40 portfolio. This episode explores three critical risks every retiree must address to maintain financial security through changing market conditions.
The first is sequence of return risk, which can devastate a portfolio if early withdrawals align with a downturn. Listen to James share his concept of "Root Reserves", setting aside five years of stable investments to provide protection during turbulent periods without selling at a loss.
The second is inflation risk. Even modest 3% inflation can nearly triple the cost of living over a typical retirement. This makes growth investments essential, even for conservative retirees, to preserve purchasing power across decades.
The third is behavioral risk. There is an emotional side of investing is often overlooked. Understanding personal comfort with volatility is just as important as the numbers. Different types of fixed income play different roles, from providing liquidity to acting as portfolio ballast during market stress.
By analyzing cash flow needs, time horizon, and risk tolerance, retirees can create a portfolio built to weather any financial storm.
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Advisory services are offered through Root Financial Partners, LLC, an SEC-registered investment adviser. This content is intended for informational and educational purposes only and should not be considered personalized investment, tax, or legal advice. Viewing this content does not create an advisory relationship. We do not provide tax preparation or legal services. Always consult an investment, tax or legal professional regarding your specific situation.
The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
Comments reflect the views of individual users and do not necessarily represent the views of Root Financial. They are not verified, may not be accurate, and should not be considered testimonials or endorsements
Participation in the Retirement Planning Academy or Early Retirement Academy does not create an advisory relationship with Root Financial. These programs are educational in nature and are not a substitute for personalized financial advice. Advisory services are offered only under a written agreement with Root Financial.
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In just the past five years, we have had three US market downturns of 20% or more, we've had the worst ever five-year time period for US bonds and we've had plenty of headlines that will cause even the most disciplined investors to get a little shaky in their thoughts about the future. So what can you do as an investor to design the right portfolio, heading into your retirement? To make sure that you're giving yourself the best possible chance of success. That's what we're going to talk about today. Sure that you're giving yourself the best possible chance of success. That's what we're going to talk about today and when we talk about that. Really, this comes down to understanding what are the three biggest risks that you face that I face, that every single investor faces, that we need to protect against. We don't want to start with just a 60-40 portfolio. Traditionally, that was thought of as the retirement portfolio you're going to have, because that has the right mix of stocks and bonds, but that's not unique to you. What's unique to you is building a portfolio that protects against the three biggest risks. What are those risks? Number one volatility. How do you ensure that you are protecting against sequence of return risk? We're going to talk about that in just a second. Number two is inflation risk. How do we not make sure that we're so focused on the volatility risk, on protecting against that, that we lose sight of an even bigger risk, which is the risk of inflation eroding our purchasing power over the course of our retirement? And then, finally, number three is the emotional or behavioral risk of how do you structure the right portfolio to minimize the chance of us making a bad mistake by making the wrong decision at the wrong time. So let's dig into that Number one, that risk of volatility.
Speaker 0:This is probably the thing that's on most investors' mind. What do I do if I retire? In 2008 happens again? What do I do if I retire and the market drops 30, 40 plus percent and it takes five years to recover? This is often the biggest fear behind something called sequence of return risk.
Speaker 0:Sequence of return risk says it doesn't matter what your average return is over the course of your retirement. If you're 65 and you're living until 90, I'm not so concerned about the average return your portfolio is going to achieve over that time. I'm more concerned about the sequence in which you receive those returns. If the first few years you get very strong returns, that's going to give you incredible tailwinds going into retirement. You're probably going to have a very good outcome On the flip side. If the first few years of returns that you get are less than ideal or maybe are even quite poor, that's going to give you an incredible headwind that you're facing going into retirement.
Speaker 0:So how do you protect against that? Well, you protect against that by realizing that if you look at the stock market the S&P 500, so a collection of the 500 or so biggest companies here in the US historically it's returned about 10% per year. If you get 10% per year, if you have a good enough size portfolio, you're going to have no issue, meaning most of your needs for the most part throughout retirement. But what happens when you don't get 10% every single year? Because the S&P 500 has not given 10% even in one single year? It's typically giving you much higher returns or much lower returns, and it's those lower returns than our working years. Those don't matter so much. We're putting money into our 401k, we're maxing out our IRAs. We actually get to take advantage of those lower year annual returns. But that's not the case when we're retired. When we're retired and the market drops and we're pulling money out of our portfolio. That's not a good equation. If that happens, that has the serious potential to derail your retirement. That is why, although the stock market has great long-term returns, we have to make sure we have enough in something that's stable, something that's going to be there for you, regardless of what the stock market's doing. The way I like to think about this is I like to have five years of something much more stable, much more secure, much more predictable set aside, something that's not invested in the stock market. Even the highest quality stocks, the most stable stocks, those do and will continue to drop in value quite substantially, even in some years. So I like to have five years set aside.
Speaker 0:Internally at Root Financial, we call these our root reserves. What is our root reserve? Well, it's making sure that if the market drops on average. We have to understand that an average bear market in the US lasts about two and a half years, but that's average. What if it goes longer than that? Well, what if we have five years set aside, almost thinking like the emergency fund for your portfolio? We have the stocks, we have the growth engine that's probably going to continue to do quite well over time, but it will go through a serious downturn, and that serious downturn could take several months or several years even to fully recover. So by having these root reserves, by having these funds set aside, what it's giving us is it's giving us the ability to say, when stocks are down, we think they're going to recover. History has showed us that every single time, historically speaking, a diversified portfolio has recovered. But it might take some time. So while that's happening, do we have funds here? These can be CDs, these can be bonds, this can be cash, this can be anything that's not subject to the serious downturns that the stock market is. If we look at that, I almost like to think about even laddering that.
Speaker 0:Do we have enough money in year one for year one expenses that if the stock market drops? This is super short term, super high quality, not going to get a huge interest rate there, but that's okay. The role this is playing isn't growth, it's protection. It's the moat around the rest of our portfolio, it's the protection around the rest of our portfolio, so something that we can live on. Then maybe you have your so year one, you've spent it. Stock market's still down, still not going to touch the rest of my portfolio.
Speaker 0:I needed my year two money. This can be a slightly longer duration bonds or CDs or whatever the case might be for your specific portfolio, a little bit more in interest, but by the time we need it, we have that available to us. And then same thing for year three, year four, year five. So how much do you put there? Well, this depends upon how much you need to pull from your portfolio.
Speaker 0:If you're a retiree, let's assume that you have Social Security. That is $3,000 per month, and let's assume you need another $4,000 per month from your portfolio. To use round numbers, let's assume you have $1 million in your portfolio. Well, $4,000 per month is $48,000 per year. I'm simply going to round that to 50 to do simple math. $50,000 is how much you need set aside to cover one year of living expenses. Well, keep in mind, we want to cover five years of living expenses. We want to ensure that there's something set aside to cover five years of living expenses in case there's a serious market downturn. So what do we do with that? We take $50,000 and multiply it by five. $250,000 in this example could be thought of as being set aside to give you that reserve, to give you that stability, to say that, even if the market drops and takes five years to recover, we don't have to spend down our stock portfolio in that instance. We can simply draw money from this part of our portfolio.
Speaker 0:That's how I like to think about protecting against volatility. That's how I like to think about protecting against sequence of return risk. Sequence of return risk is really saying that if things are going down quite a bit, how do we prevent ourselves from having to sell those investments? That's the worst case scenario. You do that by having the right amount of funds set aside that are more stable, more secure, less in long-term growth potential, but that's okay. That's not the role that those funds are playing in our portfolio. So that's step one is how do you protect against sequence of return risk? Define the amount that you need. We call this root reserves. You can call it whatever you want, but it's that amount that's stable and is gonna give you that runway that's needed when the stock market drops quite substantially. Number two the second risk that you need to be incredibly mindful of is inflation risk, purchasing power risk.
Speaker 0:People can become so focused on how do I protect against the next downturn? They put too much money into those types of investments I described for step one. They put too much of their money in conservative investments. It feels really good. It feels really good in the short term because you're not seeing your portfolio balance go down in value. In fact, if the stock market's going down quite a bit, there's a good chance your portfolio actually goes up in value. So it feels really good in the short term.
Speaker 0:But what's going to happen one day is you're going to go to the grocery store and realize things are costing a whole lot more than they used to. You're going to go buy some new clothes and realize these cost a lot more than they used to. You're going to put gas in your car or you're going to get electricity for your house and realize this costs a lot more than it used to. That's the concept of inflation. In fact, if inflation increases by just 3%, then over the course of the average person's retirement the overall cost of your living is going to go up about 250%.
Speaker 0:If your money is too conservative, it is too stable. If it's not getting the growth that it needs, you'll be safe in the short term against sequence of return risk, against volatility. You're incredibly exposed. Long term, the exposure there is the erosion of your purchasing power. You will still have the nominal value of your portfolio, but if that portfolio is not growing to keep up with inflation, it could be disastrous for your long term goals. So that is why, even in retirement, you do need to have a good allocation to types of investments that are going to grow with you so that can keep up with inflation, so that your purchasing power can continue throughout retirement. So that's how you think through step number two Step number one is protect against sequence of return risk. Step number two is protect against purchasing power risk. Real quick if you've not already subscribed to this channel, please make sure that you subscribe. Make sure that you do so. Every single week there's videos coming out saying how can you have a better retirement. Make sure that you subscribe so you get notified as that happens. Step number three the third risk here that hasn't yet been addressed is more of that emotional, that behavioral risk.
Speaker 0:Let me go back to the example I gave in step number one. I said what if you have $3,000 per month coming in from social security? You want to spend $7,000 per month. So you pull $4,000 per month from your portfolio. Assuming a $1 million portfolio, you're taking out about 5% per year or so from your portfolio. That 5% is about $50,000 per year. Well, let's change some of those details. What if you're not spending $7,000 per month? What if you're only spending $4,000 per month? That means you only need $1,000 per month or $12,000 per year from your portfolio. If I apply the same logic as before, take $12,000, I multiply it by 5, that gives me $60,000. If you have a million-dollar portfolio and $60,000 needs to be in bonds, that tells me that 94% stocks and 6% bonds could be an ideal allocation for you in that scenario. Now here's the thing From a risk capacity standpoint meaning how much risk can you afford to take without being overly sensitive to sequence of return risk? That checks that box. From a purely financial standpoint, that could potentially be the right portfolio.
Speaker 0:We're not purely financial people. We're emotional people, we have fears, we have sensitivities. We have these things that we don't need to try to pretend they don't exist. That's the reality of who we are and you have to understand that. If you, as an investor, are retired with a 96% stock portfolio, some of you listen. This would say James, that's totally fine by me. I do not like bonds. I don't want this anywhere near my portfolio. Great, if you have the appropriate mix and stable investments to ensure that you can do that, more power to you. But if you are listening and saying, I've been through market downturns, I don't ever want to go through that again, let alone go through that again where I'm not actually putting money into my 401k, I'm actually pulling money out of it. That is a very fair, a very real thing and you need to protect against that risk too.
Speaker 0:This is similar to step number one, where you do have enough money in stable investments. Again, we call that the root reserves very intentionally defined maturities and qualities of the bonds or the fixed income that we're using there. This is a little different. And step three it's what's the appropriate additional amount to add? More so to control for the emotional aspect of it, more so to control for the overall aspect of it, more so to control for the overall volatility and the feeling that that's going to bring when the markets are down, meaning even if you don't need that money in bonds for the protection they provide. It can provide that emotional protection. It can provide that behavioral protection.
Speaker 0:Now, if you're going to do that, it's not necessarily. It could be, but not always going to be, the same exact types of fixed income that you use for step one. Step one I like to think about using fixed income that is very short-term and then increasing in duration, increasing in maturity, almost like a bond ladder or a CD ladder, to provide that protection For this third step, for more of this emotional or behavioral aspect, you might wanna think about what types of investments aren't there for a defined maturity or defined aspect. You might want to think about what types of investments aren't there for a defined maturity or defined duration, but they're more going to be negatively correlated to the rest of my portfolio. Ideally, if this over here zigs, this is going to zag. Think of it as more like a ballast for your portfolio that's smoothing out the returns. Same concept of step number one, but different in terms of its application. But as we start to wrap this up there, this is how I recommend you think through what should be the allocation to stocks and bonds, specifically in your retirement years.
Speaker 0:Throw out this notion of a 60-40 portfolio is right for everyone. There is no single portfolio that's right for everyone. Start by understanding your cash flow needs from your portfolio and have enough in short-term fixed income to be able to protect against that. Make sure you understand what your purchasing power risk is. That's the risk of inflation. Do you have enough growth assets to protect against that over time? And then finally, number three, understand your own risk tolerance. Understand your own comfort level with investing. Do you need to make some additional adjustments to your portfolio, not for pure financial reasons, but to make sure the experience it's going to give you is going to be something you're comfortable with. That's it for today, if this has been helpful. Once again, please make sure that you subscribe to this episode. If you need help defining or creating your own portfolio for your retirement needs, reach out to us. This is what we do all day, every day at Root Financial. We are financial advisors. Portfolio construction is not everything, but it is certainly an important component of your long-term financial strategy. Thank you.
