Frank and Fiona Eff are a bright couple who saved diligently for their retirement years throughout their adult lives. Each is 50 years old, their children have been raised and launched, and each loves their respective job at ABC Corporation. Frank and Fiona enjoy the challenges and connections of their work so much that they plan to stay at their careers another fifteen years before enjoying a retirement filled with family, travel, and giving back to their community. Fortunately, each has a pension plan, and each will enjoy relatively generous Social Security benefits. Though they have been saving inside and outside of retirement plans since the age of 22, they aren’t sure they’ll even need to draw from those accounts due to anticipated regular retirement inflows.
Sam and Sally Ess have also enjoyed a wonderful life. Similarly, they are 50 years of age and successfully raised and launched their family. Sam and Sally are aiming for an early retirement to pursue their passion for the outdoors. They intend to spend their retirement years hiking, enjoying our country’s national park system, and volunteering with their local wildlife conservancy. While Sam and Sally were also diligent savers, neither can claim pension plan benefits. Their monthly Social Security income, though comparable to the Effs, will not sustain their current standard of living and for that reason they plan to begin withdrawing from their savings accounts shortly after retirement.
It’s possible that both the Ess family and the Effs had some level of professional financial guidance in preparation for their retirement years. It’s also possible that their retirement planning consisted of no more than a hodge-podge of broker advice, Google searches, tips from brothers-in-law, or the “strategy” of dividing an equal percentage of their 401(k) contributions into each available fund. And then there’s luck – or a lack of it.
“Rules of thumb” as a place to begin
Because retirement planning is complex, people with and without professional advisors frequently rely on “rules of thumb” when determining asset allocation (what percentage of your wealth you apportion to each investment category, one of the most important variables in planning). Rule-of-thumb strategies are based on the characteristics of an “average investor,” and ease of use is their most attractive quality.
Rules of thumb can help simplify decision making by providing a place to begin with complex issues. Average-investor allocation models – used as a starting point – can sometimes be helpful. However, if you’re using them as the start and end of your financial guidance, expect trouble ahead.
To begin with, the average investor (the mythical model for various rules-of-thumb) is a fictitious entity. Every investor departs from “average” to some degree. Also, changing tax codes, longer life expectancies, and other environmental factors regularly render old frameworks obsolete. In spite of this, too many advisors rely solely on rules of thumb in the creation of their cookie-cutter financial plans, and too many self-managers do the same.
Financial advisors, on the other hand, deal with deviations all the time. They are adept at spotting important variables among their clients, and they know how to respond to them in ways that static approaches miss. Though rules of thumb are certainly not all bad, for many people who trust their retirement to a rule-of-thumb model, the cost of missed returns in using one may turn out to exceed the cost of professional advice.
We see this with the Eff family and the Ess family. These couples have dramatically different needs. However, advisors who follow “standard” asset allocation guidelines do both of them a disservice.
Age as a factor in asset allocation
Here’s an example: According to a common rule of thumb, we should invest 100%, minus our age, in stocks. This would guide a 30 year old – any 30 year old – to a portfolio of 70% stocks and 30% bonds. To accommodate longer life spans, recommendations recently changed to 120 minus your age. It’s surprising to discover this advice mentioned by well-known financial news providers such as CNN Money and respected experts such as Vanguard Funds’ late founder, John Bogle. In fact, more sources than not will point both the Effs and the Esses to the same asset allocation formula.
While it is reasonable to consider age as a factor when determining the best asset allocation and easy to apply a one-size-fits-all formula to families who have a lot in common, taking a much broader and more thoughtful approach could have helped the Esses keep up with the Effs in retirement.
SYM advisors believe investors should structure asset allocation based on their expected near-term need for cash distributions from the portfolio, not their chronological ages. This practice should then be tempered with the investor’s ability to disregard short term market swings. Simply said, dollars an investor wants to access within seven years could be allocated to less volatile investments such as bonds. The beauty of this strategy is that as time goes by, the more you can ignore the bumpiness the larger your gains will likely be over your investing career.
Frank and Fiona Eff know their current cash flow needs are met by their salaries. In retirement, they will look forward to their pensions providing a stable and comfortable base of support – with or without distributions from their investment portfolio. As a result, even during precipitous market swings and unfounded calls for disaster, the Effs can invest more aggressively than peers who do not enjoy these post-retirement income sources.
Conversely, Sam and Sally are better served to place 35% to 50% of their portfolio in lower-risk bonds. Because they are leaving steady jobs for an early retirement, the Esses’ need for access to cash is immediate. Without the safety net of a pension, Sam and Sally will depend upon regular distributions from their investment portfolio to replace their salaries – even when markets are down. It’s been said that the only people who truly lose in a down market are those who sell. At their retirement, if the Esses’ income depends on regular draws from their equity account, they could easily find themselves selling when the markets are not at their best. This wipes out a large percent of their savings, which feels particularly painful because it was avoidable.
Navigating the ups and down of a stock portfolio
While nobody likes to see their stock portfolio drop, rolling with the ups and downs is a necessary evil of investing. To increase your likelihood of success, only risk dollars you don’t need for many, many years. At the same time, fight the urge to be more conservative than necessary, especially when time is an asset. Concerns over possible loss are reasonable and prudent. Still, to the extent of your ability, compartmentalize your concerns and ask yourself, “Even if a down market doesn’t recover for months or even years, do I think it will recover over the course of five or seven years? And am I willing to tolerate the downside so I can take advantage of the upside?”
There’s no shame in admitting you are unable to tolerate the bumps. Knowing your personal appetite for investment turbulence is extremely important. In a low-risk moderate-return scenario where portfolio disbursements will provide a significant percentage of retirement income, a good financial plan can and will be adjusted to reduce lifestyle expenses now to make ends meet in retirement.
Assessing one’s allocation needs is fundamental to SYM’s client service methodology, and when paired with complex strategies around rebalancing and minimizing the tax impact of portfolio gains, this approach increases the likelihood that our clients can enjoy the retirement they strive for. Wherever you are on the path to retirement, don’t fall into the trap of using overly simplistic rules of thumb for important life decisions. The future will be here faster than you may believe. Appreciate if your situation warrants trusting a professional wealth advisor to help you see the nuances beyond the average.
This article was previously published by SYM in September 2016.
Disclosure: The opinions expressed herein are those of SYM Financial Corporation (“SYM”) and are subject to change without notice. This material is not financial advice or an offer to sell any product. SYM reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This is not a recommendation to buy or sell a particular security. SYM is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about SYM including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. SYM-20-65.