How to Fill the Hole in Your Retirement Plan
It’s not impossible, but it does require a level head and planning.
Bloomberg, April 16, 2020
You have been diligently working, saving and investing for retirement. You put in 40–60 hours per week for almost 50 years. At long last, you get to kick back, play bridge, golf, fish, whatever pastimes you enjoy. You no longer have to punch the clock or answer to The Man. A retirement of leisure is your reward for a lifetime of labor.
Then the pandemic hit.
The economy tanked, your equity investments lost a third of their value, and bond are yielding diddly. All of your plans have been upended. WTF are you supposed to do now?
Well, don’t panic. The good news is you have options. Start with these five things and your odds go up for a secure retirement..
No. 1. Develop situational awareness: This phrase comes from the early days of military aviation and was defined as “the perception of environmental elements and events with respect to time and space, the comprehension of their meaning, and the projection of their future status.”
This applies as equally to someone with a bogie on their 6 as it does to anyone with a portfolio of stocks and bonds.
Objectively assess the risks around you. Understand the range of potential outcomes for your investments; learn what has happened historically. Prioritize the most important inputs, remove the nonsense in your information diet. Focus on helpful, informative, and accurate sources; steer clear of the hysterical recession porn. Perhaps most important of all, recognize what is – and is not – within your control.
No. 2. Have a “decumulation” strategy: How much of your assets will you draw down each year? This is a tough question that depends on many unknowns, including inflation, interest rates and bond yields, financial needs, even longevity. William Sharpe, winner of the 1990 Nobel prize for his work on a model that’s critical in making investment decisions, called the use of savings in retirement “the nastiest, hardest problem in finance.”
The key to successfully managing this: Having a financial plan that recognizes the unknowns, then focusing on your goals.
Every plan should help you understand exactly what you can spend comfortably each year. Without this kind of a strategy, you risk either failing to spend what you want and can, or worse, outliving your money. Working from a position of detailed knowledge instead of guesswork is the best way to have a stress-free retirement.
No. 3. Understand risks of fixed income: The spread between the highest and lowest quality bonds always seems to tempt some investors. Don’t forgot the lesson of the 2008-09 crisis: Chasing yield is an expensive and foolish proposition. And just because the Federal Reserve now is buying low-quality bonds doesn’t mean you should.
Here’s how to think about debt. Bonds serve as ballast against your equities. They also produce income. But most importantly, they promise a return of — not on — capital.
Because fixed-income should be part of any diversified portfolio, it’s best to stick with investment-grade bonds. One can never go wrong with high quality corporate debt. I also like Treasury Inflation Protected Securities, or TIPS, as a modest hedge against inflation. Look for opportunities in the municipal-bond markets, especially general obligation bonds — but only from entities that are not overly indebted. We probably won’t see too many state defaults, but you can expect some scary moments from places like New Jersey and Illinois. If you’re near retirement, those are best avoided.
High-yield, or junk, debt can look appealing. But be careful. Look at what happened to the biggest high-yield exchange-traded funds the past few weeks: iShares iBoxx High Yield Corporate Bond ETF and the SPDR Bloomberg Barclays High Yield Bond ETF fell 22% and 23%, respectively, last month; both are still down more than 10%. Anyone who wanted to cash out or to rebalance their holdings was disappointed. 1 Is that little bit of extra return worth all the extra risk?
No. 4. Reduce risk, cost and concentration in equities: The obvious tradeoff with equities is that they provide higher expected returns than bonds because they carry more risk. That means not only the possibility of not generating the returns you hoped for, but stomach-churning volatility along the way. But because of generally rising longevity, you can’t afford to be without them.
The solution is simplicity: Replace all of your individual stock holdings, expensive actively managed funds and alternative investments with broadly diversified, cheap index funds.
For those in or near retirement, the risk of holding any single stock is simply too high. As fabulous as Apple and Google and Amazon have been, they have had declines of as much as 80% at various times. Like those junk bonds, you do not want to have to tap into these when they have fallen that much.
No. 5. Pivot from saving to spending: This is trickier than it sounds, especially during times of turmoil in the markets. The key to this is as much managing your money as your mindset.
We have seen recent retirees become paralyzed when it comes to spending their savings. Surprisingly, underspending can be a larger issue for retirees than is living beyond their means.
Software programs can help. Every financial adviser uses these to determine how much can comfortably be spent each year. You can also find retirement calculators online that do something very similar. Use them.
You traded decades of your life on the job in return for the chance to enjoy your retirement. Do it right and the tradeoff will have been well worth it.
1. Yes, you could have soldduringthe crash, but a) you took a substantial hit on prices; and b) there was also a substantial discount to tonet asset value. These would have been bad sales. Investment-grade bonds rarely perform this poorly; they call them junk bonds for a reason.
I originally published this at Bloomberg, April 16, 2020. All of my Bloomberg columns can be found here and here.