More than Risk Tolerance
I recently spoke with a prospective client who felt good about his investment strategy, but needed advice on tax efficient withdrawal strategy and creating his blueprint for retirement. He’s one year from retiring. When we started talking about his investment strategy, he was 90% invested in an S&P 500 index fund and 10% cash and conservative funds or bonds.
This story acts as a perfect example of how to know when an investment strategy like this one could work well, and when it might actually harm your retirement plan.
This client knew he had a high risk tolerance and was ready to map out his income plan to see how much he needed and play into various outcomes to see how it could potentially pan out. So he already knew that the ideal investment mix in etirement is more than just how much risk you can take – it’s really three things.
Your Ideal Investment Mix is 3 Things
First is risk tolerance and comfort level, and the second is how much risk do you actually need to take in your investments? You can understand what that is for you by finding out how much you want to withdraw from your savings and investments in retirement.
For him, let’s pretend that he had 1 million invested for retirement, and his income plan only required him to use $2,000 per month from his investments. If you withdraw $2,000 per month, then maybe a 90/10 mix could make sense for him. And when I say 90/10, I’m talking about 90% growth investments that probably fluctuate more. And then 10 being conservative assets, which would be a little bit more of a smoother ride. If we’ve got 2,000 a month, times 12 months, he’s gotta take $24,000 out of his investment accounts each year. Now, if he had a 90% growth to 10 conservative mix, and he had a million dollars, that 10% is about 100K or so. Well, that 100K could be about four years worth of taking out 24K per year. And that could make a lot of sense for him. It’s first figuring out what’s possible, and what you need, and then designing what you want.
Diversifying Your Assets
For instance, someone might be more comfortable with having 50% of their IRA in cash, let’s say. Well, if you map out their retirement income plan, they might find out that because of inflation and other things, it might not look that great. For this client example, after we mapped out his plan, he was able to have a really high chance of success, even if he lowered his risk down, and lowered the expected return from his investments.
With his current plan and the withdrawal amount, he had options, so that was a great place to be in, but there’s one more important thing that he was missing from his investment strategy.
So what was that last important thing that was missing from this person’s investment plan? He was okay with high risk, but he also had home country bias. He wasn’t diversified. If you’re not a hedge fund or a professional investor, staying diversified can really benefit you, especially if you’d like to smooth the ride a little bit. Many of our clients prefer to – when they get to this retirement period – have a little bit of a smooth ride now that they’re not adding to their accounts anymore, but instead they’re making withdrawals. So asset allocation is very important in retirement, especially if you can have assets that do well during the different economic seasons that we may go through.
What Worked for This Client
So for this client, we built out his plan, we used historical averages, and then we used lower-than-expected rates of returns to see what would happen in that case. The last 30 years for him, when he was experiencing down periods, he actually took advantage of those because he was adding each month from his paycheck into his 401k. Dollar cost averaging can have a lot of benefits as you’re continuing to add every month, but for the next 20 or 30 years, he’s gonna be taking out money consistently every month. He is basically reverse dollar cost averaging, which could work against him during market dips.
This is why defining that income and then that withdrawal plan is so important. It gives you an idea of what sort of risk you need to take for your retirement plan to be successful, and how much you should have in the conservative bucket or the moderate bucket, or the growth bucket.
To recap: to figure out your investment mix, it could be a good practice to first figure out how much you want to take out of your savings or investments each month, then design that retirement income plan, and then work backward to see what sort of investment allocation could fit into that plan. If you need help with this, feel free to reach out to us or schedule a call.
If you want to plan your retirement without the help of a financial advisor, check out the DIY retirement plan below.