Retirees Need To Lower Investment Expectations

October 27th, 2008  |  Published in Retirement  |  Comments Off on Retirees Need To Lower Investment Expectations

There’s nothing like taking 20% or 30% off portfolio values to really put the concept of risk into focus. This story about a cardiac surgeon is a positive one as it shows how one person recognized the volatility of the markets from the dot-com bubble burst in 2000 – 2002, and was positioned well during the recent downturn.

What worried Dr. Palanisamy, however, was a rerun of his experience in the bear market of 2000 to 2002, when his then-financial manager encouraged him to invest big amounts of money in a few high-technology areas.

“I took a big beating,” he recalls. “I knew I couldn’t afford to have that happen again.”

Today, even with the stock market in the midst of another wrenching period of losses and volatility, the 55-year-old Dr. Palanisamy is calm. Thanks to a new financial adviser, his portfolio is a blend of U.S. Treasurys, high-quality corporate bonds, high-yield debt securities, diversified blue-chip stocks and customized contracts that promise him at least part of the increases in specified stock-market indexes while limiting the losses he will have to absorb.

The lesson to learn? If you’re a retiree nowadays, follow the path of Dr. Palanisamy and manage the risk in your portfolio and learn from past mistakes.

Retirement Red Zone

September 4th, 2008  |  Published in Retirement  |  Comments Off on Retirement Red Zone

The Retirement Red Zone is a name that Prudential gives the five years before and after retirement. Red Zone is a term generally reserved for the twenty yards before the end zone in American football and it’s an appropriate term. In both football and retirement, mistakes in the red zone are magnified. Make a mistake outside of the red zone and you have plenty of room to recover. Make a mistake inside and you could cause irreparable harm. However, if you exercise care and diligence (presumably with Prudential’s help), you can escape the retirement red zone and enjoy the rest of your life.

I don’t know what Prudential offers (here’s a copy of their brochure) but here are the three risks they list, they are not totally new concepts:

  • Longevity Risk: This is the risk that you’ll outlive your retirement savings, which can cause a diminished enjoyment of life through retirement or a normal retirement followed by a shortfall near the end.
  • Behavioral Risk: If you’re short of funds, you might make bad decisions under the gun; that’s what behavior risk refers to.
  • Sequence Risk: This refers to market downturns in the red zone, which directly affects your nest egg and your retirement planning.

Those are the risks and they’re well known to more reaching retirement, but how do you mitigate them? Proper planning. You can use rules like the 4% rule (spend 4% of your nest egg each year) to estimate how much you’ll need and couple that with proper asset allocation to mitigate sequence risk.

How To Respond to Market Drops

August 25th, 2008  |  Published in Asset Allocation  |  Comments Off on How To Respond to Market Drops

Walter Updegrave recently received a question from a reader that lost over 10% of their retirement assets in the last few months (since June). The reader was wondering what they were supposed to do as they are 58 years old. Can he “wait it out?” Should he pull out and cut his losses? Walter outlines a “Retirement Home Stretch Investing Plan” that is better than his initial suggestion – pull it out and put it into a money market fund.

The Retirement Home Stretch Investing Plan is his recommendation for a stock-bond allocation that closely mirrors the 120 minus age rule. He recommended for the 58 year old near-retiree to:

Generally, though, someone your age should have roughly 60% to 65% of his retirement portfolio in stocks and the remainder in bonds. The stocks are there for long-term growth, the bonds for steady income and short-term protection. As you age, you would then gradually move more of your savings toward bonds, although even in your 80s and 90s, you likely want to keep 20% to 30% of your portfolio in stocks.

Fifty-eight minus 120 is 62… which is within the 60-65% range that Walter recommends. The bottom line is that there is no right answer since we can’t see the future so what can you do? Just make prudent choices, even if it is following a simple rule, and let the chips fall where they may.

The Home Stretch to Retirement [Money on CNN Money]

Rebalance Your Portfolio For Greater Gains

May 26th, 2008  |  Published in Retirement  |  1 Comment

Buy low sell high, that’s the mantra of Wall Street (actually, it’s probably “Buy low very often, sell high very often,” but I digress), and one that you can achieve every single time you rebalance your portfolio. Rebalancing your portfolio is a task that no one likes to do because it’s so mechanical, it’s so unsexy, but it’s so necessary and one that can guarantee that you’ll be buying low and selling high. How is this guaranteed?

Rebalancing is the act of adjusting your portfolio such that the asset allocation is shifted back to your target asset allocation. Throughout the year, your various assets will rise and fall in market value, resulting in a shift of allocation. If stocks performed better than your other asset classes, they will comprise a greater percentage of your portfolio. If you had a conservative mix of 50% stocks and 50% bonds and stocks rose 10% while bonds rose only 5%, you now have 51.16% stocks and 48.84% bonds. In rebalancing, you’d be bringing both assets back to 50% by selling some stocks and buying more bonds.

How does this guarantee buying low and selling high? If your asset allocation remains the same, you will be selling the better performers for the weaker performers. In the above example, if stocks had fallen relative to bonds, you’d be selling bonds to buy more stock. As you saw above, both can appreciate and you would shift from the better performing asset to the weaker asset.

What if you’re worried about selling a shooting star midway in its path? Well, there’s always the risk of that but since you’re only rebalancing once a year (or twice), the other benefits outweigh the possibility of that happening. Also, consider yourself banking some of the earning all the way up. Plenty of dot com folks watched shooting stars fly… and then crash, with nothing to show for it.

Target Retirement Funds May Not Be Better

May 23rd, 2008  |  Published in Asset Allocation, Retirement  |  Comments Off on Target Retirement Funds May Not Be Better

Conventional wisdom states that you should take risks when you’re younger, become more conservative when you’re older, and your finances will be better off for it. This is embodied in the typical advice for asset allocation – take 120, subtract your age, and you should have that value, as a percent, allocated towards equities in your portfolio. If you’re 20, you should be 100% in stocks. 40? 80% stocks, 20% bonds. Brokerage firms offer funds with this concept in mind, though their implementations vary slightly, by designing target retirement or lifecycle funds to this way. As the years progress, the allocation adjusts itself to meet the “rule of thumb” needs of the age group.

A recent study published in the Financial Services Review, an academic journal, shows that this isn’t necessary any advantage to his approach when looking at real-world portfolio returns. Professors Harold Schleef and Robert Eisinger of Lewis & Clark College ran simulations and discovered that such an allocation offered no advantage because of how random the stock market could be. They picked randomly a 30 year period across 80 years between 1926 and 2006 and created fictitious people with target retirement-like allocations (risky to conservative), seeing which stood the best chance of reading $1M. They found that there was only a 29% chance of making it.

Then they did the reverse (conservative to risky) and saw that there was a 45% chance of getting to a million. Going from conservative to risky was better historically! Of course they warn that you shouldn’t take this information and go all gangbusters but it’s certainly something that is noteworthy.

The Odds for a Retirement Nest Egg, Recalculated [New York Times]

How To Analyze 401(k) Fund Offerings

May 20th, 2008  |  Published in Retirement  |  Comments Off on How To Analyze 401(k) Fund Offerings

If you just opened your 401(k) or are investigating where you should be invested, my advice to you is to keep things as simple as possible. If it’s your first 401(k), or your first time looking at it with this company, it can be a little overwhelming to figure out what you should be doing. If it’s not your first 401(k), you might be worried that your investments aren’t adequately diversified versus your other investments or that you simply haven’t picked the best ones for your financial situation. Regardless of your motivation to analyze your 401(k) fund offerings, the task is still the same and can seem monumental… so let’s keep things simple.

The two things you need to figure out are cost and performance. There are a lot of options, more if your company uses a traditional brokerage to manage the 401(k) because it opens up the full range of Wall Street’s products, but sticking with mutual funds can’t be wrong. Forget active versus passive or ETFs or individual stocks, stick with mutual funds, if you want a low maintenance 401(k), and you’ll be saner for it.

So, with cost you’ll want to see whether you’re getting a good bang for your buck. Passive funds generally have low expense ratios and likely low sales expenses (active funds usually have much higher because there is more activity) and trend with the market. If you’re happy with that, as many are, an index fund is always a good option. If you want the potential for greater gains, you can look at an actively managed fund. Past performance isn’t an indicator of future performance, but what else are you going to base your decision on if not the past? 🙂

Lastly, remember to use tools to see if your diversification is in line. Are you in too much stock? Not enough bonds? Too much international and not enough domestic? Or you could just go with a target retirement or life-cycle mutual fund, they can take care of those details for you (if you trust them!).