Those saving for retirement should ask two questions:
Is my rate of return meeting my expectations?
If/when the market collapses, what protections do I truly have in place to protect my assets?
Traditional models don’t seem to be working like they used to
Traditional investment models typically employ some version of Modern Portfolio Theory (MPT). Many still hold to the belief that traditional asset allocation (as defined by MPT) is the ideal way to invest. I question this type of model in a period of rising interest rates. As interest rates rise it is hard to fathom how bonds or bond funds give one the protection they did for 35 years during a climate of falling interest rates.
Warren Buffett wrote in his annual report to shareholders, “It is a terrible mistake for investors with long-term horizons — among them, pension funds, college endowments and savings-minded individuals — to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”
Famed investor and money manager, Jim Rogers, said, “You will see higher interest rates over the next few years. In fact, interest rates will go much, much higher. We have certainly seen a top for the bond market. There is no question about that. Bonds will be going lower for many years to come.”
Bonds have been a key part of traditional investment models for the past 35 years as they have been a primary hedge against stock market risk. Conventional thinking has been tied to some blend of stocks and bonds (equities and fixed income). Those days are behind us if you believe Warren Buffett and Jim Rogers – and I do.
If bonds are not a good hedge against stock market risk, what is?
Again, I go back to Warren Buffett. Mr. Buffett has done two things in anticipation of a major stock market crash. One, he has warned his investors that a 50% stock market crash is “inevitable”. Two, he has accumulated $118 billion in cash in order to weather such a crash and also to take advantage of a crash and be able to buy companies at much lower prices.
If we were to take that down to the level of the average person, I believe it would tell us to put a substantial portion of our money in cash and be ready for this “inevitable” crash. It would further tell us to be ready to deploy that cash when others are selling stocks – when the intense pain that huge losses can cause is inflicted on investors. In other words, the Buffett model is to accumulate cash when others are buying and to buy when others are selling.
An alternative approach
I use a version of Warren Buffett’s approach. My mathematical model “tells” me to sell positions and accumulate cash as prices rise and to be patient so I can deploy that cash when prices drop. I do not use bonds or bond funds because of the reasons stated above. My approach is different from Buffett’s, however, in that I use index and sector funds rather than individual stocks.
No single approach is perfect and can avoid all losses in a severe market crash. I believe that my approach can minimize losses and shorten the duration of those losses. Investors need to be prepared for the fact that deep losses will occur in the market, have some way to minimize those losses, and have some method to take advantage of real buying opportunities when prices are lower.
Warren Buffett quote
Warren Buffett once said, “ Be fearful when others are greedy and greedy when others are fearful.”
Past performance is no guarantee of future results. While active management seeks to produce higher returns than those of passively managed portfolios, historical pricing patterns, which are a component of our mathematical model, may not necessarily be repeated in the future. This type of strategy is not suitable for all investors and there is no guarantee that your investment objective will be met or that you will not incur losses, including loss of principal.
Please click on the embedded links for specific details related to sources and comments cited in this article.
Reppond Investments, Inc. is an independent investment advisor registered in the States of Montana and Washington. We may not transact business in states where we are not appropriately registered, excluded or exempted from registration.
Your needs in retirement are based on how much your anticipated living expenses will be. This can vary significantly based on several factors. Some examples include whether or not you have finished paying off your home mortgage, the amount of travel you have planned, and the costs associated with the activities or entertainment you will enjoy in retirement.
As a “rule of thumb” (according to NerdWallet.com), income during retirement “should aim to replace 70% to 90% of your annual pre-retirement income through savings and Social Security. For example, a retiree who earns an average of $63,000 per year before retirement should expect to need $44,000 to $57,000 per year in retirement.” Obviously, some of the costs associated with employment will diminish in retirement – i.e., those associated with commuting, lunches, clothing, etc.
Use a Retirement Income Calculator
The website cited above, NerdWallet.com, provides a calculator to help determine your income needs based on your personal situation.
There are usually several sources of income in retirement. Some of the most common sources are Social Security, pensions, annuities, 401(k), savings, and part-time employment.
How much are my Social Security benefits?
Here is a helpful guide from the Social Security Administration that discusses the following topics:
- Where to find your Social Security benefits
- How much Social Security benefits to expect based on the age they begin – and the benefit of delaying filing for benefits
- The effect outside income has on receiving benefits
- Children and spousal benefits
- Taxes owed on benefits received
Additional Social Security resources:
How Does Work Affect Your Social Security Payments?
Determining Your Eligibility and Estimated Benefits
You may want to consider “rolling” your 401(k), 403(b) or 457 plan into an IRA or a Roth IRA. If you follow the IRS guidelines, there will likely be no tax on this “rollover”. The IRA or Roth IRA will give you control over how your money is invested. If you can afford to defer making withdrawals, all of the money in the account can have a chance to grow until it is needed at a later date.
If you need to use the funds from a 401(k), 403(b) or 457 plan for supplemental income, you will need to determine a realistic rate of return on the invested money. This needs to assume that the stock market will rise and fall during your retirement years. Inflation and taxes will also need to be factored in as you determine the expected returns from your holdings.
Available part-time jobs
Finally, it is important to consider Medicare benefits (or private health insurance) for you and your spouse, your health and that of your spouse, and your interest in part-time employment. Part-time jobs are useful as supplemental income and are helpful as a cushion so that you can help needy family members. Work also keeps a person active and involved in an activity outside the home, and might involve charity work, which may or may not include being paid a salary. Here are some helpful websites related to part-time employment in retirement.
7 Reasons to Work Part Time in Retirement
10 Part Time Jobs for Retirees
60 Creative Way to Make Money in Retirement
A key issue in retirement is the assurance that you have enough income to sustain yourself, regardless of how long you live and as your health needs change in later years, while hopefully enjoying those years with your family and loved ones.
Ben Reppond is CEO and Investment Manager of Reppond Investments. Reppond Investments, Inc. is a registered investment adviser in the States of Washington and Montana. We may not transact business in state where we are not appropriately registered, excluded or exempted from registration. Individual responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation will not be made without registration or exemption.
Investment Advisory Services offered through Reppond Investments, Inc.
Traditional ways of minimizing risk with retirement investments have been upsetting and frustrating to investors. Investors have been told to add bond funds to their stock type mutual funds to mitigate risk in their portfolio. This mixture is intended to operate somewhat as an “insurance policy” against downside stock risk. Investors tell me that this has not worked for them. Many are leaving traditional investment managers who advocate this approach.
Why traditional methods work poorly
Many advisors still believe in broad allocations to different types of equities and bonds for retirement investments. There is a degree of protection there, but as a general rule, the more diverse the portfolio, the lower the returns. Downside risk is still higher than most investors are comfortable with. The best evidence of this is to talk with someone who is broadly diversified. The ones I speak to are generally not happy with their investment results.
I have done research into the reason most equity mutual funds perform poorly: They typically include investments in volatile sectors of the economy that exaggerate market swings and put a drag on investments. Good examples of this are stocks related to energy (oil). Based on the sector ETF XLE, for the last two years, oil stocks and indexes that include oil stocks have put a drag on broad market indexes. The S&P 500 Index, for example, has exposure to 39 energy related companies. No one tells the investor this. All the average person knows is that they are getting poor returns with higher volatility than they would like.
Why do advisors recommend stocks and mutual funds that perform poorly?
It is hard to speculate on the exact reason, but I frequently see the output of poor advice. Sometimes advisers are required to sell investment products that make their company (and in turn the adviser) the most money. Other times it may be because the underlying fund pays additional compensation to the adviser.
If there were a real answer to this dilemma, it could significantly help people preserve and grow their retirement assets. Many people’s retirement investments are unable to keep up with the market/inflation, putting them further behind on their financial goals than planned.
People find themselves with financial professionals who they want to trust but who put them into investments that perform poorly over time. When they look at their real rates of return, it leaves them dismayed and frustrated.
What concrete steps can a person take to minimize risk and potentially grow their retirement nest egg?
I saw this same dilemma and got the same poor advice when I sold my company and was looking for a way to protect and grow my own money. Based on my research and experience, I believe there are 4 simple steps you can take:
- Recognize you have a problem; avoiding it is not going to make it get better.
- Be willing to get away from the same old traditional answers that lead nowhere – except to shift some of your money from you to the financial adviser.
- Please call me. I can help you analyze what you have and why it may not be meeting your expectations. It probably has a lot to do with the types of mutual funds in which you are invested.
- While I cannot guarantee the performance of your portfolio, I can show you solutions that I created to potentially minimize risk. You can view the real time performance of my recommended portfolio strategies through this link to an outside third party vendor that tracks my performance: https://www.reppondinvestments.com/investment-strategies
Experts agree on this:
Investment professionals agree that all investments can have times in which they are more “out of favor” than others. It is seldom possible to see these “out of favor” periods coming. Therefore, most investment managers agree that taking risk is unwise for shorter term “time horizons”, especially when it is known that a distribution or liquidation is likely to occur. As investors approach retirement, they may want to reduce risk as much as possible.
A primer on investing:
A traditional approach to minimizing risk is to mix “equity” type investments with “fixed income” type investments. Let’s first break down each of these types of investments.
“Equity” type investments typically refer to individual stocks, mutual funds or exchange traded funds (ETFs). Mutual funds or ETFs are often comprised of a hundred or more stocks of individual companies. A mutual fund or ETF that specifically tracks the performance of a stock index (like the S&P 500 index) can itself be comprised of hundreds of individual company stocks.
A stock in an individual company has both “stock risk” and “market risk”. “Stock risk” means that, if a company fails to achieve its earnings projections, loses market share, or has a change in management or the direction of the company, its stock may suddenly decline steeply in value. These types of issues may not affect other companies in that same industry or even the stock market in general.
“Market risk” typically means that, in purchasing equity type investments, when the stock market declines in value, many companies may experience losses in their stock price, even though that particular company did not itself experience any issues. In other words, investors can experience an overall decline in investment value due to circumstances which affect all or most companies.
Limiting the use of individual stocks and moving money into stock type mutual funds or ETFs is an excellent strategy for lowering stock risk in a person who is approaching retirement. It must be pointed out that, while there may be market risk reason to follow this strategy, there may also be other reasons not to do so, including but not limited to the tax implications of such a change. Before undertaking this strategy, one should consult with a tax professional and a financial advisor.
Another general investment category is called the “fixed income” type of investment. This refers to individual bonds, bond mutual funds or bond ETFs. Companies and governments often borrow money through the issuance and sale of bonds. When an investor buys a bond, or invests in a bond mutual fund or bond ETF, they are, in effect, participating in the lending of money to that entity.
Bond prices, as well as the value of shares in bond mutual funds and bond ETFs, are directly affected by interest rates. As interest rates rise, the price of bonds tends to fall – and vice versa. Bonds, bond mutual funds and bond ETFs tend to move in the opposite direction from equity type investments. While this is not always true, frequently this is the case. It can be understood from this that to lessen the volatility of the equity type investments mentioned above, balancing those investments with some bonds, bond mutual funds or bond ETFs may mitigate some risk.
Conventional approaches to minimizing risk
A commonly used approach to reduce risk is a 60/40 allocation – 60% of a portfolio would be comprised of equity type investments, while 40% would be comprised of bonds, bond mutual funds or bond ETFs.
Another common strategy is to make the bond-type exposure approximately equal the investor’s age, with the remaining percentage of invested funds in equity type investments. This approach tends to lower the volatility (price fluctuation) of the investment portfolio as the investor ages or approaches retirement, a time when many people are not in a position to take much risk.
A final conventional approach to minimizing risk is to move all or some portion of one’s investments into money market funds. Another low risk asset alternative is the use of US Government Treasury Notes or Certificates of Deposit (CDs). These type instruments are among the lowest risk type of investments. If an aging investor is extremely risk-averse, using money market funds or their equivalent could better serve their goals.
401(k) and 403(b) Withdrawals Rollovers
When a person leaves the employment of a company where a 401(k) or 403(b) investment is held in that person’s name, they typically then have the option to transfer the vested portion of money in their account into an IRA (or perhaps even a Roth IRA) in their own name. This type of transfer is called a “rollover”. When that money is transferred to an IRA, that account is called a Rollover IRA or Rollover Roth IRA. It is important to check with the plan or Plan Administrator for the details, because the ability to “roll” money out of a plan and into an IRA or Roth IRA is actually granted by the plan itself. For the purpose of this writing, differences or pros and cons of IRAs vs. Roth IRAs will not be discussed. If an individual is changing from one employer to another, it is also possible to “roll” the money over from one 401(k) or 403(b) plan with one employer to a similar plan with another employer, providing the plans allow that.
A little known provision in 401(k) or 403(b) plans is called an “in-service withdrawal” provision. Investopedia defines an in-service withdrawal as “a withdrawal made from a qualified plan account before the holder experiences a triggering event. A triggering event, such as reaching a certain age, or leaving an employer, is often needed to be able to withdraw funds from a plan, such as a 401(k).”
This in-service withdrawal provision allows participants in 401(k) or 403(b) plans to “roll” their vested account balances over into their own IRA before they actually attain normal retirement age (but are over age 59 ½). This then allows the individual to have greater control of their investment account and to direct their investment options of these tax-favored dollars as they approach retirement.
For more information, see the following article. http://www.anthonycap.com/blog/service-withdrawals-401k-plans-law-and-plan-rules
As mentioned above, tax implications should be given careful consideration and can influence one’s decision to sell one asset and buy another, along with one’s personal risk tolerance. This is especially the case if one’s money is in a taxable account. Investments that are in IRAs, Roth IRAs, 401(k) and 403(b) plans are not affected by decisions to sell one type of investment within the plan and buy another.
Retirement investing: summary
While we can make no guarantees, we believe there are many ways to minimize or reduce risk as one approaches retirement. The first key is to take charge of your own money as much as possible. The second key is to get personalized and sound advice from multiple investment professionals. It is important to compare and contrast the level of risk being advised as retirement approaches.