The biggest mistake I see retirees make is not properly preparing their portfolio for retirement plan distributions. How can you design a proper retirement portfolio transition plan to hit your retirement bullseye?
Let’s say we have a meaningful market decline in the first few years of your retirement—about 20% or more. If that happens, you may be forced to sell stocks when they’re down while you are also taking retirement portfolio distributions out of your investment portfolio . The impact of doing both in the first few years may jeopardize your ability to take retirement withdrawals for the remainder of your retirement. You might run out of money earlier than you thought you would.
We call this risk “sequence risk.” It’s the risk that the first few years of retirement will produce negative returns first followed by positive returns versus producing positive returns first followed by negative returns. In both cases, your average return might be the same, but if those negative returns happen first, when you withdraw money actually has a significant impact on the result of your retirement projections and your ability to live your lifestyle the way you want to.
How do you deal with sequence risk? When you’re saving or accumulating money, your investment is for one goal. All your money should be aligned for growth and you should be investing pretty aggressively. When you retire, think about your money in two buckets—an income bucket and a growth bucket.
Your income bucket represents the first three to five years of living expenses you need to have out of your retirement portfolio. Let’s say that’s $30,000 a year. You might set aside $90,000 to $150,000 into a separate account different from the other money. You might decide that three years is too much or five years is too long, but the idea is to set aside some dollars for future consumption. We believe that works better psychologically.
What would you invest that “income bucket” money in? Likly CDs, treasuries, and bonds that mature consistently with the timing of when you need those cash flows. You can invest the other bucket—the growth bucket—into more aggressive securities like stocks because you have time to allow those to recover in case they go down during the first few years of your retirement.
When’s the best time to consider this retirement transition portfolio strategy? We think it’s a minimum of five years and a maximum of 10 years before you need withdrawals from your portfolio before you should consider this income and growth approach.
If you only have one account, like a 401(k) plan like most people do, you can still implement this retirement transition plan strategy, you just need to do it inside of the same account. When you look at your statement, you just need to know what’s for income and what’s for growth.
If you’d like to understand how a properly designed retirement transition portfolio can work for you, give us a call, shoot us an email, or message us on our website and ask one of our Certified Financial Planners ™ for a consultation so they can design the perfect strategy for you. We look forward to hearing from you.