It has been said that retirement is the only time in your life when time no longer equals money. But whether you’re nearing retirement or you’re already there, it’s vital to annually assess risks to your post-working years.
Today’s retirees are facing challenges that previous generations did not. Life expectancy is longer – which means you’ll potentially need your money to last into your 90s. In addition, pensions are more problematic; more employers are moving away from defined benefit pensions and into defined contribution plans – which are subject to swings in the market.
Here are some worthwhile strategies to consider for protecting your retirement:
Investing in an Age of Low Interest Rates
With short-term interest rates fixed around zero for the next few years, the Federal Reserve has made it difficult for retirees to get sufficient income on savings. Because interest rates are so low, retirees should not base their investment strategies entirely on cash or other reasonably safe sources.
Instead, if they are to ensure they won’t outlive their assets, retirees need to own some combination of bonds, stocks and other non-cash assets.
The Federal Reserve continues to inject money into financial markets and the economy, and this process intentionally keeps interest rates low. Retirees should make sure they’re using some conservative income strategies that will provide a dependable source of cash flow regardless of the Federal Reserve’s activities.
Holding more cash, but with a better yield, is another income approach. In fact, it can be part of an overall portfolio strategy. Keeping 15% or a little more in cash may help to soften the impact of twists and turns in the equity area of a portfolio, helping an investor to tolerate volatility.
Many high-yielding bank money-market accounts currently yield under 0.50%, less than an investor might get from bonds or some stock dividends. To improve on this, cash that isn’t needed right away can be put into a bank Certificate of Deposit. CDs pay more than most money-market accounts; their downside is that there is usually a penalty if the funds are withdrawn before they mature.
Another alternative is an 18-month CD, which has a somewhat better yield. The investor can create a “ladder,†buying a new 18-month CD every six months and reinvesting the proceeds as each matures. This way, an investor can obtain higher CD rates while earning cash that can be spent or reinvested when one matures.
High-grade corporate bonds are also an option. Short-maturity corporate bonds that carry investment-grade ratings of triple-B or higher will probably continue to generate good yields. That said, it’s wise to avoid lower-rated, so-called high-yield corporate bonds; they yield more, but their prices can bottom out in situations where investors decide to flee from risk.
Preferred shares are an alternative to common stock and bonds. They trade like stocks, but make regular payouts like bonds. And when companies make payments, those holding preferred – as the name suggests – get preference over holders of common stock. The yields on preferred shares can be attractive, but they do come with risk. For example, a large rise in long-term yields can result in lower principal values.
Finally, equities can give investors a reasonable cushion over inflation – currently around 1.6%. Known as ETFs, or equity-traded funds, some can generate yields above 3% by investing in blue-chip companies. Because of the larger income component that higher-yielding ETFs contain, they also tend to decline less when stocks are falling.
Combatting Sequence- of-Returns Risks
Timing is everything – and after you faithfully invest and save for years, it can be difficult to accept that making withdrawals from a retirement account can negatively impact your overall rate of return. During a weak economy, it can significantly affect the retiree who now depends on the income but no longer contributes new capital that could offset losses. The term used to describe this situation is sequence-of-returns risk, or sequence risk.
Also, while it’s possible to have some control over when we retire, we can’t control what the market does after we retire; account withdrawals during a bear market are more costly than the same withdrawals in a bull market. If you retire when the market is enjoying growth and the economy is sound, your account may grow large enough to sustain a subsequent downturn. If you retire when the economy is receding and stocks are declining in value, your account balance may struggle to recover.
Sequence risk is a matter of luck, but there are opportunities to help limit the downside risks.
For starters, be realistic about how long you can expect to live, along with your ability to work. Recent research shows that at least one member of a 65-year-old couple now has a 90% chance of living to 80 or beyond. Living longer affects key retirement decisions, such as how to invest, when to claim Social Security and whether you may need long-term care. Your ability – and desire – to continue working is a related factor. While more than two-thirds of retirees say they expect to continue working until at least age 65, the reality is that less than one-third are actually still working at this age.
This increases the importance of investing a portion of your portfolio for growth so you can maintain purchasing power over time – as well as having a backup plan in case you leave the workforce sooner than you anticipate.
During difficult times, overspending or mistiming withdrawals can devastate a portfolio. Alternatively, reducing discretionary spending during these same periods, or proactively “harvesting†for future spending needs during favorable markets, can produce better results.
It may be useful to coordinate dependable income sources, such as Social Security and fixed income, with fixed retirement expenses including housing, food and healthcare. At the same time, matching investments with more discretionary expenses such as travel or a new car.
Some other strategies to help avoid, or lessen, sequence risk:
- Consider working as late as you can so you can contribute more to your retirement account – especially during your peak earning years.
- Keep saving and investing after you retire. If you’re past age 70-1/2, you can still contribute to a Roth IRA or open a personal investment account.
- Diversify your portfolio with high-quality corporate and government bonds.
What is a “safe†annual withdrawal amount for retirees?
One popular rule of thumb for retirement spending is the 4% rule. It states you can comfortably withdraw 4% of your retirement savings in your first year of retirement and then adjust that amount for inflation for every subsequent year without the risk of running out of money for 30 years.
While it sounds wonderful in theory, and may actually work for some people, there is no right answer for everyone.
And if you’re following this rule without considering whether it is right for your situation, you could end up either running out money prematurely or left with a financial surplus you could have spent on things you enjoy.
The 4% rule assumes your investment portfolio contains about 60% stocks and 40% bonds. It also assumes you’ll keep your spending level throughout retirement. However, the 4% rule is an older rule, first established when bond interest rates were much higher than they are now. Today, your portfolio is more sensitive to changing market conditions and how your investments will perform in future years.
Finally, you can realistically expect your spending patterns to change throughout retirement – and the 4% rule doesn’t factor this in. Most retirees are more active in their early retirement years, with hobbies and travel that boost their spending. In the middle years, spending usually falls, before rising again because of health care issues late in life. Thus, 4% may be too little in your early years and too much in your later years.
The bottom line is that the 4% rule can be used as a starting point, as well as a basic guideline for how much to save for retirement – 25x (or the inverse of 4%) of what you’ll need in the first year of a 30-year retirement. After that, it may be advisable to adopt a spending plan based on your situation, investments and risk tolerance – and regularly updating it.
Here are some additional considerations in developing a personal spending plan:
- How long do you want to plan for?
To get a general idea, consider your health and life expectancy, using data from the Social Security Administration and your family history. Consider, too, your tolerance for managing the risk of outliving your assets, such as access to other resources like Social Security, a pension or annuities.
- How will you invest your portfolio?
A good mix of cash, stocks and bonds is important, and can affect the portfolio’s ending asset balance; a more aggressive asset allocation can potentially grow more over time, but the “bad†years are worse than with a more conservative allocation.
- Are you willing to make changes if conditions change?
The 4% rule assumes you won’t change spending or investments as conditions change. But reducing your spending during a down market will increase the likelihood that your money will last, as will changing your investments or making other adjustments.
- Are you factoring in non-portfolio income?
In determining your annual spending, remember to include Social Security, a pension, annuity income and other non-portfolio income. For example, if you need $50,000 annually but receive $10,000 from Social Security, you only need to withdraw $40,000 from your portfolio.
- Can you anticipate some capital gains?
Rather than just interest and dividends, a balanced portfolio should also generate capital gains. Investments should help to deliver stability and growth to help your portfolio last.
Whether it’s combating the risk of sequence of returns or navigating the 4% rule, there are cash flow and tax strategies that can help improve the success of your retirement plan.
REDW Wealth financial planning advisors are experienced with strategizing retirement planning opportunities that help our clients maximize income and reduce taxes. For an initial one-hour complimentary consultation, please contact Paul Madrid, Principal and REDW Wealth Practice Leader or access his calendar to schedule a time most convenient to you: Schedule 1 Hour Zoom Meeting.
