Frank and Fiona Eff are a bright couple who saved diligently for their retirement years throughout their adult lives. Each is 50 years old, their children have been raised and launched, and each loves their respective job at ABC Corporation. Frank and Fiona enjoy the challenges and connections of their work so much that they plan to stay at their careers another fifteen years before enjoying a retirement filled with family, travel, and giving back to their community. Fortunately, each has a pension plan, and each will enjoy relatively generous Social Security benefits. Though they have been saving inside and outside of retirement plans since the age of 22, they aren’t sure they’ll even need to draw from those accounts due to anticipated regular retirement inflows.
Sam and Sally Ess have also enjoyed a wonderful life. Similarly, they are 50 years of age and successfully raised and launched their family. Sam and Sally are aiming for an early retirement to pursue their passion for the outdoors. They intend to spend their retirement years hiking and enjoying our country’s national park system, and volunteering with their local wildlife conservancy. While Sam and Sally were also diligent savers, neither can claim pension plan benefits. Their monthly Social Security income, though comparable to the Effs, will not sustain their current standard of living and for that reason they plan to begin withdrawing from their savings accounts shortly after retirement.
It’s possible that both the Ess family and the Effs had some level of professional financial guidance in preparation for their retirement years. It’s also entirely possible that their planning consisted of no more than a hodge-podge of broker advice, Google searches, tips from fellow investors or brothers-in law, and luck – or a lack of it. Far too many families throw darts at the wall hoping to stumble across the magic formula of stocks and bonds to invest their hard-won dollars.
People without professional advisors often rely instead on “rules of thumb.” Such solutions seem attractive in their ease and reduced cost, and can be a helpful tool for simplifying and solving complex issues. In fact, many brokers implement them as a part of a cookie-cutter financial plan. But the truth is, asset allocation (where you place how much of your investments) is not the type of issue you want to trust to a computer-generated, preordained formula. In fact, it is far too complex a concept to be solved with any rule of thumb, and the cost of missed returns can easily exceed the cost of professional advice.
We see this with the Eff family and the Ess family. These couples have dramatically different needs. However, advisors who follow “standard” asset allocation guidelines do both of them a disservice.
Here’s an example: According to a common rule of thumb, we should invest 100% of our assets, minus our age, in stocks. This would guide a 30 year old – any 30 year old - to a portfolio of 70% stocks and 30% bonds. To accommodate longer life spans, recommendations recently changed to 120 minus your age. It’s surprising to discover this advice mentioned by well-known financial news providers such as CNN Money as well as respected experts such as Vanguard Funds founder, John Bogle. In fact, more reputable sources than not will point both the Effs and the Esses to the same formula.
While it is reasonable to consider age as a factor when determining the best asset allocation, and easy to apply a one-size-fits-all formula to families who have a lot in common, perhaps it’s too easy. SYM recommends doing away completely with asset allocation rules of thumb and taking a much broader and more thoughtful approach – one that could have helped the Esses keep up with the Effs in retirement.
SYM advisors believe investors should structure asset allocation based on their expected near-term need for cash distributions from the portfolio, not their chronological ages. This practice should then be tempered with the investor’s ability to disregard short term market swings. Simply said, dollars an investor will need within seven years or longer should be allocated to less volatile investments such as bonds. The beauty of this strategy is that as time goes by, the more you can ignore the bumpiness the larger your gains will be.
Frank and Fiona Eff know their current cash flow needs are met by their salaries. In retirement, they will look forward to their pensions providing a stable and comfortable base of support – with or without distributions from their investment portfolio. As a result, even during precipitous market swings and unfounded calls for disaster, the Effs can invest more aggressively than peers who do not enjoy these post-retirement income sources.
Conversely, Sam and Sally are better served to place 35% to 50% of their portfolio in lower-risk bonds. Because they are leaving steady jobs for an early retirement, the Esses’ need for access to cash is immediate. Without the safety net of a pension, Sam and Sally will depend upon regular distributions from their investment portfolio to replace their salaries – even when markets are down. It’s been said that the only people who truly lose in a down market are those who sell. At their retirement, if the Esses’ income depends on regular draws from their equity account, they could easily find themselves selling when the markets are not at their best.
While nobody likes to see their stock portfolio drop, rolling with the ups and downs is a necessary evil of investing. To increase your likelihood of success, only risk dollars you don’t need for many, many years. At the same time, fight the urge to be more conservative than necessary, especially when time is an asset. Concerns over possible loss are reasonable and prudent. Still, to the extent of your ability, compartmentalize your concerns and ask yourself, “Even if a down market doesn’t recover for months or even years, do I think it will recover over the course of five or seven years? And am I willing to tolerate the downside so I can take advantage of the upside?”
There’s no shame in admitting you are unable to tolerate the bumps. Knowing your personal appetite for investment turbulence is extremely important. In a low-risk moderate-return scenario where portfolio disbursements will provide a significant percentage of retirement income, a good financial plan can and will be adjusted to reduce lifestyle expenses now to make ends meet in retirement.
Assessing one’s allocation needs is fundamental to SYM’s client service methodology, and when paired with complex strategies around rebalancing and minimizing the tax impact of portfolio gains, this approach increases the likelihood that our clients can enjoy the retirement they strive for. Wherever you are on the path to retirement, don’t fall into the trap of using overly simplistic rules of thumb for such important life decisions. The future will be here, faster than you may believe. Make the decision to trust a professional wealth advisor to help you see the nuances beyond the “standard.”