The novel coronavirus abruptly ended the longest bull market in US stock market history.  As we write this in spring of 2020, the broad stock market indices are down about 25% from the peak reached just a few weeks ago.  If you are retired or approaching retirement, you are probably concerned about how this global pandemic will affect you. Now might be a good time to review your portfolio in the broader context of your retirement plan.  You may decide to make some adjustments to ensure that you are still on track for a secure retirement.

While you might be understandably anxious about how much value your investments have lost, the real issue is whether or not your financial plan for the future still works.  If it does, you can relax. Your investments will eventually recover. If it does not, you can take corrective action to get back on track for a secure retirement.

A Retirement Plan

A financial plan for retirement has several important elements.  You need to know how much you will spend in retirement. People often struggle to come up with a budget for retirement, particularly if they are still years away from retiring.  The easiest way to figure out what you will spend in the future is to consider what you are spending currently and then imagine you are retired today and think about how the numbers will be different.  For example, you might spend less money on commuting and clothes for work, but more money on gardening and travel.

Also, separate your spending into fixed and variable expenses.  Fixed expenses are permanent (e.g. utilities, property taxes, insurance, food, etc.) and will not vary significantly.   Variable expenses change for various reasons (e.g. replacement vehicles, child’s wedding, a big remodel, travel, etc.).   Make sure to account for inflation (particularly for health care which will likely be higher), as your expenses will go up over time and threaten a secure retirement.

Now consider your income sources.  You will likely have Social Security and you should generally plan to take it as late as possible (i.e. age 70).  You may also have a defined benefit pension plan, rental property income, part time work, etc. You can also take distributions from your investments in retirement accounts (e.g. 401(k), 403(b), IRA, Roth IRA) and non-retirement (i.e. taxable) accounts.

The goal is to have your income sources be large enough to cover your spending for as long as you live.  If you plan to retire at 65, you should plan on 20-30 years in retirement, perhaps longer if you are healthy, eat well, exercise, and you have a family history of longevity.

Your Portfolio in Retirement

Now let’s turn our attention back to your portfolio.  What role will it play in your secure retirement? Are you going to receive enough income from a pension, Social Security, and perhaps other sources, so that you will not need to rely on taking distributions from your portfolio?  Or are you, like most Americans, not going to have a pension and will you, as a result, have to rely heavily on your portfolio to augment Social Security?

The answer to that question will greatly influence the way your portfolio should be constructed for a secure retirement.  Let’s assume that your portfolio will play a large role in creating income, so that you can enjoy a secure retirement. We next need to relate the size of your portfolio to the amount of income you will need to take from it.

Want to learn more about retirement planning? Contact our team at Springwater Wealth today to learn how we can help you develop a plan for your financial future.


Your Financial Need to Take Risk

Let’s say that you have $2.0 million in retirement accounts and $500,000 in a brokerage account as you enter retirement and that you need a total of $75,000 in income.  If Social Security will provide $35,000, then you need to take $45,000 from your portfolio. You will be taking 1.8% from your portfolio ($2.5M/$45,000). That is considered, by financial planners, to be a very conservative rate of withdrawal.  So, a conservative portfolio (i.e. minimum exposure to the stock market) will support that distribution rate.

What if you need $150,000 in income and your Social Security income will be $40,000?  That means you need to take $110,000 from your portfolio. In that case, you will be taking 4.4% from your portfolio ($2.5M/$70,000).  That is a far more aggressive distribution rate, and it exceeds the generally-accepted sustainable rate of 4%. In that case, you will need to accept a fairly aggressive portfolio (i.e. significant exposure to the stock market) to support your distributions.

The extent to which you need to take distributions from your portfolio will determine your need to take investment risk to ensure a secure retirement.  The less reliant you are on your portfolio, the more conservative can be your portfolio.

Your Willingness to Take Risk

How do you react to investment risk?  When investors suffered through the Great Recession which reduced the value of US stocks by 50%, what did you do?  Did you make changes to your portfolio? Did you rebalance systematically through 2007-2009? Did you sell out entirely and wait on the sidelines?

You need to know how emotionally comfortable you are accepting financial risk.  That may seem rather amorphous, but it is actually possible to measure. Our firm uses an outside resource, FinaMetrica, to assess our clients’ tolerance for investment risk.

There should be congruence between your emotional tolerance for investment risk and the riskiness of your portfolio.  For example, if you are a very conservative investor who avoids loss at all costs, your portfolio should be similarly very conservative.  Alternatively, if you are an extremely aggressive investor willing to accept losses while pursuing large gains, then your portfolio should be aggressive.  It is possible to plan for a secure retirement, regardless of your tolerance for risk.

Your Economic Capacity for Risk

What about your ability to take risks?  Let’s go back to our example and assume you have a $2.5 million portfolio and that your need for income from that portfolio is zero because you have a large pension, Social Security, and rental income.  What is your ability, in economic terms, to accept risk with your portfolio? It’s very high because you are not relying on your portfolio. In theory, you could lose all of it and you would still be able to maintain your desired lifestyle and have a secure retirement.

What if, on the other hand, you needed to take $110,000, or more, from your portfolio?  Well, that would indicate your ability to incur losses is less. If you incurred significant, permanent losses in your portfolio, your ability to generate the income you need would be greatly compromised.  Planning for a secure retirement includes understanding your (economic) capacity to incur investment losses.

We have discussed risk from different perspectives.  Your financial need to take risk is directly related to your need to take distributions from your portfolio.  The higher the rate (i.e. percentage) of income you need, the more investment risk you will need to accept in your portfolio.  Your emotional comfort with investment risk (and losses specifically) will influence the relative riskiness of your portfolio. If you are risk intolerant, your portfolio should be conservative.  Your economic capacity for risk is a function of your ability to maintain your lifestyle, if you incur losses in your portfolio. The more dependent you are on your portfolio for income, the less capacity for losses you have.

Reconciling Aspects of Risk

You might be thinking that these various aspects of risk (need for, tolerance for, capacity for) don’t always seem to line up with each other.  You’re right. They may not and that can be problematic. If you find yourself in that situation, you will need to reconcile them.

Let’s say you have determined that you need to take a moderate amount of investment risk in your portfolio to meet your income need, but your tolerance for investment risk is low and your capacity for investment loss is also low.  One strategy to address this would be to find ways to reduce your need for income from your portfolio (i.e. reduce your spending). Another might be to become a more knowledgeable investor and, thereby, increase your tolerance for investment loss and accept a more aggressive portfolio.

Monitor and Adjust

To enjoy a secure retirement, you need to balance the elements of risk in a way that works for you.  This is not something you do once and move on. Retirement is dynamic. There will be lots of change and you will need to adapt your plan and your portfolio accordingly.  If you commit to reviewing your situation whenever there has been a material change in the macro environment or in your personal circumstances, you can be confident that your retirement will be secure.