I recently saw the movie American Sniper. In honor of that movie I thought I would write about the most deadly retirement enemies. These are the combatants that can take you out unless you know about them and have a plan to protect yourself. The hazards you face during retirement are different than those you deal with during your working years. Retirees must recognize that they are entering a different phase in life which calls for a different plan of attack, especially in terms of managing wealth.
One of the menaces you face in retirement has to do with overall Asset Allocation. Asset allocation is how you spread your money across the many different investment vehicles to accomplish your goals. Investing too conservatively or aggressively and not adequately diversifying can mean your money may not last throughout retirement. The stock market is a great vehicle to build wealth over long periods; however over shorter periods it can be highly volatile and can decrease 30-50%.
Another assailant, Sequence of Return Risk, can cause your wealth to expire before you do. This is the risk of receiving poor returns at the beginning of your retirement as you are drawing money out of these investments to meet your lifestyle needs. As an example, someone who happened to retire in January 2000 and pulled out 6% a year from a portfolio invested 100% in U.S. stocks, would be completely out of money by 2012. If that same person had instead retired in 1988, they would have seen their money go up fivefold over 12 years. To either go broke or have your money go up fivefold, depending upon what the stock market is doing when you retire, does not sound like a good retirement plan. There are ways to defend yourself against this enemy. Solutions would include diversifying and picking products that are less volatile, while offering a steady stream of income. Another defense would be to have 2 years of living expenses set aside in cash. This is the money you would use to meet your lifestyle needs when the market is down, rather than being forced to sell depreciated stocks.
Another threat has to do with the drain Income Taxes can have on your cash flow over time. This is critical if you have a majority of your wealth in accounts that are taxed at ordinary income rates such as retirement accounts. There are many approaches to reduce taxes and protect against government increases in tax rates. The strategies might include: Looking at which assets to put in which accounts, deciding which assets to draw down first, knowing the different investment vehicles available that generate tax-free income and looking at various strategies to minimize taxes, such as converting part of a retirement account into a Roth.
Inflation is another enemy. This is the risk that your income will not keep pace with the rising cost of living. At an inflation rate of 4%, you must be able to triple your income over a 30 year retirement horizon. In other words, if your investments need to generate $100,000 today, they will need to generate over $300,000 30 years from now.
Lastly, the mastermind of all the retirement enemies is Longevity Risk. This is the risk that you will outlive your money. I say this is the mastermind because it magnifies the other risks. In other words, the other risks probably don’t matter much if your time horizon is 10 years, but stretch that out to 30 or 40 years and it requires a different course of action. This risk can be mitigated by having an overall plan that deals with taxes, asset allocation, inflation and various strategies to produce stable income that you can’t outlive. One critical piece to address is how to take Social Security. Most people seize the money early, which can be a huge missed opportunity to mute longevity risk. My suggestion is that every person approaching retirement should have a detailed, customized retirement plan created for them. This master plan will show you how vulnerable you are to your retirement enemies and how to structure your affairs for maximum defense and ultimate victory. You only get one shot at this; you can’t afford to miss.
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