Changes to Investments Pre-Retirement

[scfr]

DH & I are 46. The plan is to retire at 55 (possibly at 50 for DH if he makes the senior golf tour ... but the odds of that are very very slim, so realistically we're looking at 55). As long as our return on investments matches inflation and we maintain our current savings rate, we will have reached the level of savings that we will "probably" need in retirement in a little over 2 years.

I say "probably" not because I'm guessing (I'm not), but because you can never cover all of the worst-case scenarios (early onset dementia requiring 30 years in a nursing home, etc). We want to have an extra cushion in our retirement savings, to hopefully cover those worst-case scenarios, have the ability to help out some family members, and possibly leave a modest estate when we die, so we will continue saving as we have been all the way up to retirement to build that cushion.

I seen no reason not to start shifting our already fairly conservative portfolio to an ultra-conservative one, probably going as low as 0-10% stocks.

2 questions (and would love it if anyone who has already retired or who is nearing retirement with sufficient savings would chime in):

1. What is the best strategy for making the shift? Just do it all at once? Move a percentage out of stocks each year? Keep what has already been invested where it is and just invest new savings ultra-conservatively? Until we know for sure we have hit the actual number, keep doing what we have been doing with our investments (including new savings) and then start shifting funds?

2. If you were going to go with an ULTRA-conservative portfolio, where would you invest? Anything we should be looking at other than bank accounts (CDs and MMAs), Treasuries (TIPS and Savings Bonds), No-load & Low-expense Bond Mutual Funds? I think for now an annuity is out of the question, but would be delighted to consider any other suggestions.

P.S. - Just to be clear, we are not anti-stock. From the day we made our first retirement investment, we have owned stock mutual funds (or balanced funds). While our percentage in stocks has always been less than what most of the "experts" would have suggested, we never once panicked and sold during the market dips we have lived through; we just held on and rode things out. We're just at a point in our lives where we no longer see stocks as serving much of a purpose in our big financial picture.

[disneysteve]

Originally Posted by scfr

We're just at a point in our lives where we no longer see stocks as serving much of a purpose in our big financial picture.

I guess this is the point I would take issue with. You are talking about retiring in 9 years at the age of 55. Assuming good health, you may proceed to live another 30 years or more after that. If you don't build growth into your portfolio, the buying power of your savings will gradually erode over time. Now you are accounting for that to some extent by over-saving and accumulating a cushion that goes beyond what you expect to need, but I'd still argue that you need some growth as well. And I think at 46, it is too early to be getting out of stocks or cutting down to 0-10% range.

I am the same age as you so I can't speak from experience, but I know plenty of retirees who live, in part, on the dividends from their equity investments. My 80-year-old mother is among them. She holds about 8-10 individual stocks as well as some mutual funds. The stocks are all dividend-bearing and she gets regular checks that supplement her SS and other savings. TIPS are great for keeping up with inflation but I don't think just keeping up is good enough. Your own personal expenses may rise faster than the official inflation rate. For example, I think seniors saw no COLA increase this year even though the Medicare premiums went up, so many seniors saw their net income drop as a result. The equity portion of your portfolio will help buffer stuff like that.

As for how to trim your stock allocation, since I think you shouldn't be eliminating stocks from the picture, I would keep what you have and direct new money into the conservative stuff to gradually decrease your stock position that way.

[jIM_Ohio]

How low is your withdraw rate for retirement?

If you have $X in investments, and your yearly income need is $Y, what is $Y/$X. That is the initial withdraw rate.

If less than 1%, consider TIPS for 100% of assets. If you own no stocks, TIPS would be only asset I would consider.
If higher than 1% and less than 4%, I would strongly advise using Buckets approach.
If higher than 4%, then you will probably lose money (to inflation).

There is probably a solution with 100% TIPS and a 2% withdraw rate, but it should be noted that TIPS have not seen every market cycle (like deflation) and its possible your worst case is the case where this fails.

Buckets:
consider Buckets which look like this

1) Bucket 1 is cash you spend each year, maybe a TIPs ladder and is 100% cash and CDs and TIPs type investments. If you spend $Y per year, pyt 5*$Y in bucket 1
2) Bucket 2 is money which generates the cash each year. Think bonds, dividend stocks and interest. Probably about 25% equities and 75% bonds or 40% stocks and 60% bonds. It could use an annuity too. Each year you EXPECT bucket 2 to generate more cash than $Y.
3) Bucket 3 is your worst case investment. This means invest in equities (to moderation) and grow your portfolio. You only withdraw from Bucket 3 in an "up" year. If you do this, then Bucket 3 lasts forever and exceeds inflation as well.

This takes the math and basically keeps equities away from the money you need for income, but still uses some equities to grow the portfolio.

The biggest risks to a 45 year retirement are inflation and withdraw rate (not investment returns). Run 45 year monte carlo on various withdraw rates and asset allocations. For example run 2%, 3% and 4% withdraw rates on a 40-60 portfolio, then run same withdraw rates (2-3-4%) on a 60-40 portfolio. You will see more failures in the high withdraw rates more than from the 40% or 60% equities. Even knocking equities up to 75% or down to 25% will not effect the portfolio as much as inflation going .5% higher or retirement being 40 years or 45 years. With retirements that long, the math shows withdraw rates and inflation and length of life to be bigger factors than how much equities you hold, but you will want to hold about 25% equities (minimum) to see the results.

There are magazine articles in publications which document cases like your own (45-70 year retirements).

[kork13]

The others already covered it probably well enough, but IMO, you don't want to be totally out of stocks just as a matter of basic principles. Even though you'll be in retirement, you still need to be diversified in your investments. If you restrict yourself to only one type of investment (cash/bond only), you're subjecting yourself to more risk than you need to. It's a bit backwards, because we typically think of cash/bonds as "safe", but there's still the risk of earning potential. You can keep 20%-25% stocks and maintain a similar low-volatility stance while still preserving some of that earning potential. If you go totally into cash/bonds, how do you adjust in lean years for cash/bonds, such as the present? Cash accounts are making no more than 2% (mostly less than 1%), and most bonds are only just higher, making about 2%, maybe 3%. If you temper that with a small portfolio of stocks, you can keep your earnings up and not have to worry about over-drawing your portfolio. Aiming for such a long time in retirement, I should think that outliving your savings would be a top concern for you -- a small stock portfolio will allay those concerns considerably.

[disneysteve]

Originally Posted by kork13

we typically think of cash/bonds as "safe", but there's still the risk of earning potential.

Bonds, especially bond funds, also carry principal risk. If you buy a $10,000 bond and interest rates change, that bond may only be worth $9,500 or $9,000. The interest payments would continue but if you needed to sell for any reason prior to maturity, you could lose money from your initial investment. With bond funds, it is even more complicated since there is no actual maturity date. You are dependent on the fund manager to manage the risk and keep the NAV stable.

[jIM_Ohio]

Originally Posted by scfr

I seen no reason not to start shifting our already fairly conservative portfolio to an ultra-conservative one, probably going as low as 0-10% stocks.

2 questions (and would love it if anyone who has already retired or who is nearing retirement with sufficient savings would chime in):

1. What is the best strategy for making the shift? Just do it all at once? Move a percentage out of stocks each year? Keep what has already been invested where it is and just invest new savings ultra-conservatively? Until we know for sure we have hit the actual number, keep doing what we have been doing with our investments (including new savings) and then start shifting funds?

2. If you were going to go with an ULTRA-conservative portfolio, where would you invest? Anything we should be looking at other than bank accounts (CDs and MMAs), Treasuries (TIPS and Savings Bonds), No-load & Low-expense Bond Mutual Funds? I think for now an annuity is out of the question, but would be delighted to consider any other suggestions.

P.S. - Just to be clear, we are not anti-stock. From the day we made our first retirement investment, we have owned stock mutual funds (or balanced funds). While our percentage in stocks has always been less than what most of the "experts" would have suggested, we never once panicked and sold during the market dips we have lived through; we just held on and rode things out. We're just at a point in our lives where we no longer see stocks as serving much of a purpose in our big financial picture.

I did not directly answer the question the first time.

The best answer is change allocation when your tolerance for risk changes.

However, that statement leaves a lot to be interpreted (it is correct, but open to interpretation).

As I read your post you state things indirectly, and the conclusions I draw are stocks=risk. What about inflation risk, interest rate risk, longevity risk?

Inflation risk- usually seen with any cash based investment, a little less with bonds, and basically says the real return of an asset (real return=return AFTER inflation) is negative for savings accounts, close to negative for CDs and might be 0 for bonds (probably closer to 1-2%, but could be 0 for 10 year periods). Only 3 assets which are good to counter inflation risk is real estate, gold/ commodities and stocks. Another way to hedge this risk is to borrow money.

Interest rate risk- the risk that interest rates change, that interest rates changing also changes the value of some investments. As interest rates rise, the value of bonds drops, as rates drop, the price of bonds go up, as rates drop, the returns on cash based investments (savings, CDs) drops.

Longevity risk- the risk that savings does not last or the net worth/ value of your investments does not last. If you keep a 25% equity position, IMO this rate is countered if withdraw rate is about 2.5% for 45 years.

If the risk is not based on return, but based on volatility instead... meaning your risk aversion is that you see a portfolio of $ 2M one year, then a portfolio of $1.5 M the next, then $1.75 M the next, what you want to do is remove high equity exposure, and I would be curious what your aversion to equities had you hold while w*rking and saving? Was it 80% or 60%. The difference between 40% equities and 80% equities is considerable relative to volatility- the average return goes down maybe 2 points (9% to 7%) but the volatilty is cut in half or more (14% to 7%). Volatilty means this...

9% return with 14% volatilty means returns vary from -5% to +23%
7% return with 7% volatilty means returns vary from 0% to 14% in same markets.

Take away the negatives (a 40-60 does this reasonably well) and someone's aversion to equities might change.

[scfr]

Thank you, all, for taking the time to write such thoughtful responses. All will be taken in to careful consideration.

TIPS: I'm a fan and have had a little bit in TIPS ever since they first came out (individual TIPS through Treasury Direct). Not sure how I feel about investing 100% in any one thing tho. jIM_Ohio, do you prefer owning individual TIPS or owning through a mutual fund?

Regarding inflation risk: While I agree wholeheartedly that with a money market account paying the average national rate, cash savings are not going to keep pace with inflation. However, my belief (based on experience) is that with a willingness to rate shop and a high enough cash balance so that you can purchase jumbo CDs, open MMAs with high balance requirements, etc, you CAN keep pace with inflation and usually outpace it by a little bit.

(BTW: Initial withdraw rate = higher than 1%, lower than 2%)

Again, thank you very much for all the comments & suggestions.

[jIM_Ohio]

Originally Posted by scfr

Thank you, all, for taking the time to write such thoughtful responses. All will be taken in to careful consideration.

TIPS: I'm a fan and have had a little bit in TIPS ever since they first came out (individual TIPS through Treasury Direct). Not sure how I feel about investing 100% in any one thing tho. jIM_Ohio, do you prefer owning individual TIPS or owning through a mutual fund?

Regarding inflation risk: While I agree wholeheartedly that with a money market account paying the average national rate, cash savings are not going to keep pace with inflation. However, my belief (based on experience) is that with a willingness to rate shop and a high enough cash balance so that you can purchase jumbo CDs, open MMAs with high balance requirements, etc, you CAN keep pace with inflation and usually outpace it by a little bit.

(BTW: Initial withdraw rate = higher than 1%, lower than 2%)

Again, thank you very much for all the comments & suggestions.

With a 2% withdraw rate, I would suggest a portfolio which resembled this:

Put 10 years expenses in a savings account (cash based investment). Rate chase as you are now, put 1 years expenses in account 1, year 2 in account 2, year 3 in account 3... and this should also let you find jumbo rates.

Invest the rest of portfolio into a 25-75 allocation. The 25% stocks should be divided into 3 categories:
a) dividend paying stocks (15% of stocks)
b) foreign stocks (large cap- 5% of stocks), preferably dividend payers
c) REITs (5% of stocks)

75% bond position would be in TIPs. If you have enough money, ladder the TIPs and stay away from bond funds. You appear to have the time to rate chase, so having time to manage the ladder is less work than that, IMO.

I suggest individual TIPs because it removes the idea that rising rates lower the value of a fund's share price. If an investor had less cash to start with, TIPS mutual funds work, in this situation you are going "all in" or close to it, with TIPs, so I advise to own the bond itself to remove risk of losing principal in a rising rate environment.

I suggest 25% equities because inflation risk is still there, and you will barely notice 25% equities, and dividend payers tend to much (MUCH!!) less volatile than any other type of stock. Dividends also tend to exceed inflation (the payout tends to be higher than reported inflation).


If you did not like my advice, it is worth exactly what you paid for it. Even if you paid me, I would not change my mind (much). Inflation risk is real, and you are planning for a 45 year retirement. If you make it to year 25 with 25% equities, consider going (more) conservative then, but too many unknowns exist to ignore inflation risk even if there are 75% position in TIPS.

Here is an article at morningstar
http://news.morningstar.com/pdfs/Inc...omeWork sheet

Focus on first page
focus on 40 year column
focus on 95% success rates
and see a 3.3% withdraw rate works regardless of allocation (meaning for conservative or aggressive, or for everything in between, the lower withdraw rate trumped the allocation to give the high success.

Keep some equities in portfolio to generate the 95%+ success rate, just keep them to minimum.

The biggest difference will be the amount (size) of portfolio left after 40 years.

[scfr]

Sorry to reply so late.
We did a consult with a CFP (we like to get some expert input once in awhile), and were happy to get confirmation that we are on track to reach our goals. He did not have any problem with the conservative nature of our investments.

We have not shifted any of our retirement funds yet, but what we are seriously considering is moving some or all of the funds that are in Vanguard's Wellsley Income Fund to the Target Retirement 2005 Fund. This would be a shift to a slightly more conservative & more diversified portfolio. (Haven't been able to pull the trigger yet tho. Wellsley has been good to us. I keep asking myself "if it ain't broke do you really want to try to fix it?" Not very rational, I know. I must remind myself to stop looking back at the past and look forward to the future and our retirement.)

Agreed about owning individual TIPS. That is what I have owned and will continue to own. The only thing I don't like is that I can't set up an IRA in my TreasuryDirect account. (The Target Retirement 2005 Fund is about 18% TIPS, so if we make that move we'll be adding a TIPS fund indirectly.)

And just had to add about rate chasing: yes, I absolutely take the time to do it! Anyone who is serious about taking charge of their own personal finances has to be willing to put some time in to it, right?