What the markets do in the "retirement red zone" five to 10 years before you leave the workforcecan dramatically alter what your life will be like in retirement.
Investors need to be careful not to leave their portfolios exposed to “bad luck” during those years, warned Michael Rosenbergof Prudential Investmentsin a recent Plansponsor article. Aportfolio's value can be depleted roughly twice as fast when an investor suffers a 2008-type bear market event immediately before retiring, according to the Plansponsor article, based on a Prudential study.
You "only retire once, and individuals must act to protect themselves from that worst-case scenario,” says Bob Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pa.
So, what’s the best way to make sure your portfolio isn’t exposed to bad luck come retirement?
1. Determine how much income you need.When it comes to investing during the five to 10 years prior to retirement, it pays to have a comprehensive financial plan that addresses both bad- and good-luck scenarios, experts say. And part of that plan should project how much you’ll need to draw from your portfolio over the next five to 10 years, according to Bob Pugh, president of Insight Wealth Management in Gainesville, Va.
Consider allocating the assets inyour nest eggusing what he calls his “five to 10 rule of thumb,” or what others refer to as “buckets.” Invest in:
- Safe assets such as short-term, investment-grade fixed-income securities and other low-risk assets that you can access easily for moneywithin five years.
- Relatively safe assets as well as some longer-maturity, fixed-income securities and a small percentage in blue-chip, large-cap U.S. equities for money that you’ll need in five to 10 years.
- Riskier assets with a focus on return for money that you’ll need in 10 or more years.
“This approach, I believe, combines the best aspects of financial planning and investment management to deal with risk over the short and long terms,” Pugh says.
2. Don’t just avoid risk, pool it. Like Pugh, Johnson says investors approaching retirement should have a more conservative asset allocationto protect against sequence-of-returns risk, which is the risk of having to withdraw money from your nest egg during bear markets.
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He and others recommend cutting those risksby pooling them, not just avoiding them. As pensions disappear, “Individuals should allocate some of their assets to products that act like defined benefit plans — that is, annuities,” Johnson says.
Consider investing in annuities that cover your basic needs in retirement. “If they have annuitized a portion of their portfolio, they can be more aggressive in allocating the remainder of their portfolio and take advantage of the fact that over the long haul, stocks provide a much higher return than bonds,” says Johnson.
What’s more, Johnson says sequence-of-returns risk really argues for people purchasing longevity annuities to help avoid outliving your assets. “Purchasing a longevity annuity that provides cash flow after a certain age — say 80 or 85 —helps protect investors from having sequence-of-returns risk ruin their retirement,” says Johnson.
3.Diversify away risk.Jonathan Treussard, a senior vice president at Research Affiliates in Newport Beach, Calif., suggests doing more than just “gliding” away from equities and into bonds. “Rather, one may reduce equity risk by going into low-beta stocks, thus reducing volatility while maintaining upside potential... and reduce the maturity/duration of the bonds in one’s portfolio,” he says.
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Treussard also recommends broadly diversifying, well beyond the mainstream, to includestocks and bonds in developing countries. And he suggests that you always pay attention to asset valuations. “It is easy to focus on daily price volatility and get blindsided by the very real risk that overinflated valuations may revert back to more ‘historically sensible’ levels,” says Treussard. “Better to lean ... into relatively cheap assets.”
4.Delay retirement. Nicholas Callahan, president of NP Callahan & Co. in Federal Way, Wash., suggests thatretirees might want to be flexible with their retirement dates if they have left themselves overexposed to market risk.“Retirees need to be informed and know how the puzzle fits together,” Callahan says.
Others agree. “When you retire can really affect your terminal wealth and quality of retirement,” says Johnson. “Individuals may decide to work longer if their accumulated wealth is not at the level they expected due to poor returns prior to retirement.”
5. Don’t forget inflation risk. “Inflation is a death by a thousand cuts,”says Kent Smetters, a professor at The Wharton School at the University of Pennsylvania and host ofwww.KentOnMoney.comradio show. Avoid investing in nominal bonds, which are typically not a great hedge for inflation. A broadly indexed REIT can be useful. But the better asset to consider, says Smetters, would be government bonds with inflation-indexed payoffs, such as I Bonds, Treasury Inflation-Protected Securities (TIPS)and the like. I Bonds can be purchased, up to $10,000 per person, through TreasuryDirect and TIPS can be found in various mutual funds and ETFs.
Robert Powell is editor ofRetirement Weekly, contributes regularly to USA TODAY,The Wall Street JournalandMarketWatch. Got questions about money? Email Bob atrpowell@allthingsretirement.com.
