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Should I De-Risk Near Retirement?

by | May 7, 2019

Market volatility is not something investors are typically excited about experiencing, regardless of age. However, volatility can become even more stressful as you get closer to retirement. Also, it is often assumed that once you retire, you’ll need to begin taking withdrawals from your retirement accounts to meet your living expense need. Because of this, it is generally assumed that you should invest in a more conservative manner as you approach retirement.

Not to say that this way of thinking is wrong, but it shares the same deficiencies of every rule of thumb; it doesn’t consider your personal situation.

There are some that will have an immediate need for withdrawals when they retire. However, for others, there may be a unique circumstance that causes no need for immediate withdrawals at retirement. For example, perhaps you are retiring with a pension benefit. Or, maybe your spouse plans to continue working and can earn enough income to cover your living expenses.

Whatever the case may be, we would argue that the notion that everyone needs to de-risk near retirement is not necessarily true.

Basing Allocation Your Income Need

Instead of using proximity to retirement as the primary driver for your allocation, we would suggest focusing on your projected future income needs. As mentioned above, the two could go hand in hand, but might not.

In fact, regardless of your age, we would argue that a primary driver of allocation should be the amount of time between now and the time you begin taking distributions. A secondary driver should be the amount of your distributions once you enter the withdrawal phase. The sooner the need or the bigger the amount, the more conservative you may want to be.

To figure out what your withdrawal needs are, you’ll need to know your total income needs and how much will be provided by sources other than your portfolio. For example, if your total income need is $50,000 per year, but you have $30,000 coming in from Social Security, your withdrawal need is only $20,000 per year. Finding out the answers to these questions will require you to create a cash flow projection or work with your advisor to map this out.

Framing Using a Bucketing Approach

Once you have an idea of what your withdrawal needs are, then you can start to build an allocation. For withdrawals needed within 12-18 months, it’s important to use an investment vehicle that matches that time horizon. An example of an investment vehicle with a short-term time horizon would be a money market fund, a short-term CD, a short-term bond fund, or even cash.

While these types of investments typically do not generate high returns, they do offer a higher level of safety than their more volatile counterparts, stocks.

Why 12-18 months? By keeping enough cash on hand to last for about a year, you can avoid having to sell stocks to generate income immediately after a market decline. Doing it this way gives you at least at little time for your portfolio to recover from a correction before having to sell assets at a loss to generate income.

Withdrawals Needed for Years 2-10

In the event there is a worse-than-usual market downturn, it’s important that you have backups in place to generate the income you need. We believe bonds, although they are not guaranteed to avoid losses, will be less volatile than stocks in the future over long periods of time. Therefore, if there is a major decline in stocks and your cash is depleted, bonds are another investment vehicle that could help you generate the income you need.

Therefore, you could allocate the total amount of withdrawals you would need for years 2-10 toward fixed income investments. If a market downturn occurs and you deplete your cash, you could then begin selling bonds to give your stocks or stock funds time to recover. This is sometimes called an increasing equity income method.

By following this bucketing-style approach, you would be able to provide yourself enough income for ten years without selling any stocks in the event of a major market downturn, which we believe is more than enough time for the stocks in your portfolio to recover.

So, Should You De-Risk Near Retirement?

A better question is, “Do you have enough of your portfolio allocated to cash and fixed income investments to cover your income needs for a period of ten years, should the market go through a major downturn?” If the answer is yes, then why not invest the remaining balance in equities or stocks, which we would expect to outperform other sectors over a long-term period.

Depending on the size of your portfolio and the amount you need to withdraw, the remaining balance you plan to allocate toward stocks could be 0% of your portfolio, 60%, 88%, 100%, or anywhere in between. If you use that logic and it suggests you only need 10% of your portfolio in fixed income and cash, which would be widely recognized as an aggressive portfolio, why decrease the risk further?

So, whether you should de-risk your portfolio would depend largely on the answers to these questions.

What Should You Do Now?

If you haven’t yet, now is the time to develop a plan. Doing so can not only provide a logical justification for your overall allocation, but it also might help you improve your long-term returns by empowering you to stay aggressive longer.

Maybe even more importantly, by knowing your income needs are covered for a period of 10 years with bonds and cash-like investments, it can help you stomach market fluctuations easier, as you won’t be thinking about having to sell your stocks to generate your income.

A myth many investors believe is that you need to de-risk and avoid the bad years to be “successful” as an investor in retirement. We would simply disagree.

CarsonAllaria Wealth Management does not provide tax or legal advice. All articles and posts are provided by CarsonAllaria Wealth Management (CAWM or firm) for informational purposes only. By accessing or otherwise using this Article, you agree to be bound by the terms and conditions set forth below. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the Article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the Article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. In addition, this Article shall not constitute the provision of personalized investment, tax or legal advice, and investors shall not assume this Article serves as a substitute for personalized individual advice. Information contained in this Article may have been derived from third-party sources that CAWM believes to be reliable; however CAWM does not control such information and does not guarantee the accuracy or timeliness of such information and disclaims all liability for damages resulting from such sources. Links or references to third-party websites are provided as a convenience and do not constitute an endorsement by CAWM, and the Firm is not responsible for the content of any such websites. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.

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All material provided by CarsonAllaria Wealth Management (CAWM or firm) is for informational purposes only. By accessing or otherwise using this website, you agree to be bound by the terms and conditions set forth below.

Investing involves risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced on the website, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s).

No portion of the website shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. In addition, this website shall not constitute the provision of personalized investment, tax or legal advice, and investors shall not assume this website serves as a substitute for personalized individual advice. Information contained on this website may have been derived from third-party sources that CAWM believes to be reliable; however CAWM does not control such information and does not guarantee the accuracy or timeliness of such information and disclaims all liability for damages resulting from such sources. Links or references to third-party websites are provided as a convenience and do not constitute an endorsement by CAWM, and the Firm is not responsible for the content of any such websites.

Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.

*73% of financial advisors do not have a succession plan. Study conducted by the Financial Planning Association and Janus Henderson Investors. Statistic was cited in the CNBC.com article at https://www.cnbc.com/2019/04/29/a-majority-of-financial-advisors-lack-a-succession-plan.html

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