Pitfalls of Retirement Planning

Pitfalls of Retirement Planning

Retirement portfolio management is a difficult proposition for many retirees.  There are so many ways to go wrong.  When you are in your working years, it’s possible that you have time to correct mistakes thanks to compound interest.

But once you’re close to retirement, the impact of investment mistakes will likely stay with you for life.  Your future self is dependent on the decisions that you make today.  Let’s explore a few mistakes and how to mitigate them.

Pitfall #1: I’m scared of market volatility – This one has some serious irony.  Your entire investing life to this point has shown you that investing your hard earned dollars into the great companies of America and the world will provide sufficient returns to get you to your retirement.

It has offered one of the greatest accretions of wealth that the world has ever seen.  Despite knowing this, many retirees begin to question this strategy and want to become overly conservative.  Then comes pitfall #2.

Pitfall #2: I will live on bond interest – A common theme I hear from retirees is the idea of having a portfolio that has a significant bond presence is the way to go.  After all, it’s common knowledge that as you get older, your portfolio should become more conservative, right?

There are even relatively well-known allocation calculations that push people that direction.  One such example is 100 – Your Age = % of your portfolio that should be in the stock market.

Aside from the continued historically low-interest environment, there are two significant additional problems that retirees don’t tend to think about.

Even if your portfolio principal was 100% protected (which it wouldn’t be unless you’re buying 100% treasuries), and you could manage to have a lifestyle initially based on bond interest that would be sufficient to meet your needs, you’ll soon realize that your portfolio cannot keep up with inflation.

Let me explain:

Hypothetically, you invest 100% of your portfolio into Treasury Bonds paying 4% currently on $1 million dollars.  Because of the interest rate environment, you’d have to purchase some serious long term bonds in order to achieve this, but let’s just say for this hypothetical that you could buy 10 year Treasuries at 4%.  (The current rate of 10-Year Treasuries is 2.33% for some perspective.)

This would pay you $40,000 per year, which in year 1 is exactly the amount of income you need.  By year 2, it’s still paying $40,000 and in year 9, it is still paying $40,000.

Do you think it’s at all possible that 9 years from now, you would have needed a raise?  And to compound this problem, in 10 years, you get your initial principal of $1 million back.  Then what will you do with it?

Your income has stagnated AND your portfolio has not grown at all over the same period.  Big problems.

Pitfall #3: Thinking of their portfolio value as one number.  When people get to retirement, it’s natural to take a step back to see how far you’ve come in saving for your retirement.

When you do that, you add up every investment account and have a number which represents the last 30-45 years of saving for retirement.

Knowing this number and that you’re about to retire, the natural inclination is to be conservative with your money since that’s the way you “protect” your portfolio.  But once you start to do that, what you’re really doing is succumbing to the same two arguments above.

Every pitfall is fear based.  Name any number of bad portfolio decisions, and I’ll bet that it is fear based.  Fear about volatility.  Fearing that this time really is different.  Fear that history will not repeat itself.

In every case, it’s a fear that for some reason, the next 30 years will be drastically different from the preceding 30 years.  While we can never be sure, it’s probably wise to at least assume it’s going to be something like it has been.  But at worst, it’s probably wise to plan for a variety of possibilities rather than just the negative one.

So, how can we overcome these interrelated pitfalls?

Strategy #1: Understand that your retirement date is not the finish line, but the starting line.  The average non-smoking couple retiring at age 62 has a joint life expectancy of 92 years old. This means that their portfolio will need to last 30 years from the date that they retire. 

Any idea approximately where the market was 30 years ago?  The DJIA closed on 31 December 1987 at 1,938.  Yes, that is over 20,000 points below where it is today.  And that doesn’t even include dividends!!

This is not a way of saying that the compounding growth over the ensuing 30 years will be the same, but that at any point during the past 30 years, there have been numerous reasons to “fear for your portfolio’s life”.  And yet, as time has marched on, those issues worked themselves out and the market has continued to move ever higher with temporary setbacks.

The older we get, the harder it is to think truly long term.  But as a general rule, people reading this have lived less strenuous and healthier lives than the average person.  So, it’s likely that they have a longer time horizon than the average of 30 years.  Scary to think about I’m sure.  In any case, maintaining that longer term perspective is critical.

Strategy #2: Segment your portfolio into “buckets” with each bucket having a specific purpose.  This will help you avoid looking at your portfolio as one number and effectively create income while managing market volatility and your own emotions.

Separate your total portfolio into three buckets: cash, fixed income, and equities.  The cash and fixed income buckets are there solely to provide income during inevitable market downturns.

Having that safety net helps ensure you won’t need to liquidate your equities at inopportune times.

The equity bucket is there to provide income to you during the good times and hopefully, over the long run continue to appreciate allowing your income to grow over time as your costs are rising.

The amount that you invest into each bucket is dependent on the percentage that you need to withdraw to maintain your lifestyle and your total portfolio value.  But at least this way, you can take a step back from your portfolio to make better decisions.

By structuring your portfolio to allow for income, growth, and managing your own emotions is critical to your long term retirement success.



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