So, you’ve built an investment portfolio over the last two to three decades and you’re headed for retirement. Now what? Some investors think they should raise their hands in victory, crash through the finish-line tape, and then sit back and collect their rewards.
Not so fast, you might say, as most investors actually have anxiety about how to make what they spent most of their lives accumulating, last long enough in retirement
Building a retirement portfolio is, essentially, the halfway point in the race. The second half is sustaining the retirement lifestyle you imagined. Even if you are still in the accumulation phase, it is not too early to begin thinking about the second half of the race—building a sustainable retirement.
Why? Because creating a sustainable retirement is a highly complex planning challenge.
Retirement planning has completely changed over the past few decades, and it continues to evolve. One of the biggest changes was the shift from pension plans to individual retirement plans. This is where the complex challenge begins for many of today’s investors.
Pension Plans vs. Individual Retirement Plans
Pension plans offer the advantage of statistics-based management. A pension fund is just a large pool of money that is managed based on averages, with the average lifespan being the most significant statistic. For a pension fund, a single individual’s lifespan isn’t relevant; instead the key to successful management of the money pool is to correctly gauge the average lifespan for everyone in the pool. (Successful pension funds must correctly estimate many other factors, too, but the major factor is lifespan.) Once a pension fund has some accurate averages, investment decisions can be made based on the rate of return needed to satisfy its obligations. While that can be a daunting task, it’s not as daunting as the task facing individual investors.
An individual investor starts with a much smaller pool of money and a statistically undefinable problem. They are faced with the same issues as pensions – making investment decisions based on the rate of return needed to satisfy obligations; however, individuals usually cannot accurately gauge the size of their specific obligation. For example, an individual who lives for just five years after retirement needs far fewer financial resources than an individual who lives for 30 years after retirement. To plan a sustainable retirement, an individual investor needs to correctly estimate a single lifespan – his or her own – which will probably not fit the statistical average. To further complicate matters, lifespan statistics can change. For example, medical advances tend to add a few years to an average lifespan. Additionally, an individual’s spending expectations, which differ widely, should be part of the overall planning process.
Unlike pension plans, where answers lie in correctly interpreting group statistics, the answers to an individual retirement plan are as unique as the individual. Add market uncertainty and a low interest-rate environment to the equation and you have created more anxiety to retirement planning.
That’s why building a sustainable retirement can be so hard.
How to Build a Sustainable Retirement
So, what’s an investor to do?
For younger investors, fully grasping the elusive nature of retirement planning is the first step. Effective retirement planning involves much more than contributing to your 401k. It’s a journey that benefits from thoughtful planning and expert advice. That’s why investing early, continually tracking your assets, and adjusting your strategy can help you go the distance in your retirement.
The key is to find a disciplined investment strategy that strikes a balance by providing the diversity, risk-tolerance, and flexibility you need.
For investors who are nearing retirement, or are already retired, take a deep breath. Anxiety-driven investors can become more short-term focused, which could damage your long-term goals. The key is to find a disciplined investment strategy that strikes a balance by providing the diversity, risk-tolerance, and flexibility you need.
Yield-seeking is currently in vogue for many older investors. The concept is simple: Invest for yield and spend only that income, leaving your original nest egg untouched. Voilà, you have created a stable income source and you haven’t touched your original nest egg. Your future is secure, right? Maybe.
In today’s low interest-rate environment, finding yields that will meet your income needs can be difficult. Purchasing high-yield debt is one approach, but that debt carries substantial risk. High-yield bonds tend to get relabeled as junk bonds during periods of high default. Perhaps a safer approach to income generation is purchasing dividend-paying stocks, but those options may also erode your nest egg. Dividend-paying companies tend to be concentrated in certain industries and usually high-growth companies do not pay dividends, so you give up some diversification if you concentrate on dividend-paying stocks.
While a yield-seeking strategy can be beneficial, it can also be deceptive, so you should fully understand the complexities behind this seemingly simple strategy before making decisions that could inadvertently erode your investment portfolio.
A skilled advisor can help you understand the relationship between portfolio growth and income generation. At Personal Capital, we take a holistic approach to investing and planning for your long-term financial goals.
To learn more, schedule an appointment with a Personal Capital advisor.
Amin Dabit, CFP®
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