If you’ve watched the financial industry over the course of the last decade, you’ve probably noticed some important contradictions. It’s a good indication that taking generalized investment advice and applying it to your own situation is not a smart idea. Anyone who retired at the height of the recession is going to understand exactly what I’m referring to.
For many years, particularly when the stock market and real estate industry were speeding along on their way to all-time highs, financial planners had a core view for retirement investment planning:
Because you — the average member of the general American public — are expected to live for two or three decades beyond the traditional age of retirement, you need assets that are going to provide the income you need for a long period of time. If, in retirement, you don’t plan to work to generate income (and if you do, it wouldn’t really be retirement), that income needs to come from your assets.
Therefore, planners throughout the decade leading up to the recession said, you need to remain invested relatively aggressively in equities — stocks, not bonds — to provide the kind of performance necessary to turn the average retirement nest egg into an income stream.
Then the country experienced an economic recession and a stock market crash. Financial planners backpedalled when questioned by recent retirees who saw their nest eggs lose 60 percent or more of their value at the time when they were beginning to withdraw their funds for income or convert their assets into annuities. “Well, you should have invested more conservatively as you were approaching retirement.”
So which is it? As the middle-class worker approaches the date of retirement — a date that can come sooner that expected if the boss wishes it so — should he or she maintain exposure to risky equities for the opportunity to make those assets last another thirty years or should he or she reduce risk to smooth out any potential bumps in the valuation road?
A reasonable person might say the answer is to “find the right balance.” Finding balance is a concept that sounds wonderful. We look for balance in all things: balance between our career priorities and family priorities, balance in the way we treat our own children, balance between enjoying life today and planning for the future.
In this case, however, striking a balance between the two opposing approaches to investing prior to retirement has a bigger chance of meeting neither goal: not protecting retirees from downward swings in the market and not extending the life of assets.
How do you approach the fateful event when you no longer trade your time and effort for income when those providing advice seem to be unsure themselves, more interested in telling a story that connects with people whose expectations change based on the overall economy and the general outlook in the financial media?
The realities of investing don’t change depending on whether the stock market is at all-time highs or long-time lows, but the advice does because it has to match what people are feeling. Is there a time that those who give advice are more right than at other times? Is the advice to remain invested in risky stocks while approaching retirement better than the advice to dial down the risk in favor of potential stability?
Asset allocation is important, and the advice given during the boom times makes the most sense for people who just haven’t been able to put away large nest eggs for retirement. Stay invested mostly in equities to give that nest egg the best possibility of lasting as long as you expect to live. Shift from aggressive to conservative later on.
There are two alternatives to avoiding this choice.
1. Grow a nest egg large enough for you to avoid risk.
The first alternative is to create a nest egg large enough that you can withdraw only one percent of your assets’ total value each year. If you can live off one percent or less of your nest egg, you can have a much more conservative portfolio while increasing the chance that it will survive at least several decades.
If you can retire today with $10 million, you’d probably be fine living with an annual income of $100,000 (or 1 percent that first year). But there are very few who will retire with a nest egg approaching that amount. Having sizable assets allows you to invest with much less risk while still being comfortable. That’s why Suze Orman invests her own millions much differently — more conservatively — than the way she encourages her middle-class callers to invest.
This alternative certainly isn’t easy. Even if you follow the tenets of “getting rich slowly,” saving as much money from each paycheck as possible, you might find yourself with an extra $1 million or $2 million in future money after 30 years. And $1 million in 30 years might have the same value as about $400,000 in today’s dollars — not exactly rich, but a little better off.
2. Retire at the best possible moment.
The second alternative is to adjust the date of your planned exit from the workforce. We like to think of retirement as the day you leave working behind in favor of a life of leisure, but for many people who find themselves needing to supplement their income, retirement might be a time to continue working, just at a different capacity.
If there is a day to stop working, that day would be when your assets have a high valuation, perhaps at the top of the stock market, if you plan to use any portion of your assets to purchase an annuity as many retirees do for the guaranteed income.
Timing is notoriously difficult because you never know whether you’re at a market top until after the fact. Also, your retirement date isn’t always completely up to you. The worst situation is when a country is experiencing a recession and employers react with layoffs. There you are, forced into an early retirement at the exact moment when retirement is probably the worst thing for your ability to generate the income you wanted during the next two or three decades.
Financial advice needs to be specific, relating to any one person’s own situation. The idea of prescribing an investing approach to a large group of people is inviting. And you can probably get more hits than misses when you have a good idea of your audience’s average financial situation. You’re pretty safe if you can say most people will do best by approaching retirement invested mostly in stocks.
But every so often, a recession or stock market crash comes around. It’s the situation that illustrates that the risk necessary to potentially receive financial rewards actually exists. You can’t change your advice because of this manifestation. It’s only after market crashes you hear planners saying, “Well, you should have been more conservative,” or, “You should only invest in the stock market what you can afford to lose.”
At all other times, the advice is, “Unless you are rich, investing carefully in the stock market is the best way to provide the best chance for growing wealth over the long term,” and thats the same advice that should apply at all times. Notice that the advice only offers a chance, not a guarantee, and for every risk you take, there’s also a chance that retiring at the wrong time could leave you with a nest egg a fraction of its former valuation.
Published or updated April 12, 2013.