Retirement Answers

Hey there. Welcome back to another episode of Retirement Answers. My name is Jacob Duke. I'm a certified financial planner, and I am your host as always. In this episode, we're gonna be talking about something that you should not do before you retire, and it's something I see is pretty much commonplace.

Like, it's a general understanding of what you probably should do. It's like what we've been taught from our parents, media outlets. Basically, all retirement understandings come down to, hey. You should do this. And I'm gonna try to explain perhaps why you maybe shouldn't do that or why it might end up being bad for you to do so.

And what is the thing that you should avoid? Well, it is that you should not get too conservative in your investments as you are approaching retirement or while you're in retirement. Now I do wanna caveat that and say there is a perfectly valid reason for this. Like, we all think that we should be a little bit more conservative, obviously, than we were before retirement because we're no longer working. We're not earning an income.

And so that would justify having a little bit more safety around us from an investment standpoint. So, just to get started, let's lay some groundwork. We've all been taught by our parents, other advisers, blogs, newspapers, the news. Basically, everything we've been taught about retirement is that you should dial back the risk in your investment portfolio before you retire, and you should get really conservative. Now you probably know what I'm talking about, and you probably feel this way if you're someone who is either in retirement or who is about to retire.

But I have a quick question. Why should we get more conservative? Well, here's some common reasons. You know, I'm retired now, so I need to protect my money. I can't afford to lose any money in the stock market.

I wanna make sure my money lasts the rest of my life. I'm retired now, so my time horizon is a lot shorter. And all of those reasons are very common, and they're valid. I agree with you on some of those things. They are a reason to be fearful and kinda concerned around, hey.

I don't wanna take as much risk. But can I be honest with you? Those fears are often rooted in misunderstanding, And it what it really comes down to is simply human nature. We, are fearful of uncertainty. It's just the way we are as humans, and I can't fault you for that.

It's just the way that we are wired. And the way we feel about money is often an indicator of what we understand about money. So the reason I can say that most of the time, our fears are rooted in misunderstanding is because we don't understand risk properly. I figured out over the years that the idea of investing ultraconservative in retirement is more about risk than anything else, or maybe should I say perceived risk. And so I have a question for you.

What is risk? Like, what is it actually? And, there's a book that I like to give to all my new clients, and I've started giving this to all my new clients, and it's called simple wealth, inevitable wealth, and it's by Nick Murray. If you'd like a copy of that, email me at jacob.duke@appliedcapital, and I'd be happy to, get your address and send you a copy. But it is an awesome book from understanding, what risk is and what risk is not and what risks we should look out for that we don't think are risks.

And so this book, simple wealth, inevitable wealth is a great one to understand how to invest properly, how to do it for a long time really well, And it's something that I go back to all the time. Now, as Nick Murray explains in the book, what risk is and what risk isn't, we've got to identify these things. We've got to understand what true risk is and what true risk isn't. So we're gonna look at these from a retiree standpoint, and we're gonna walk through these together. So what is a risk that a retiree could face?

Well, investment risk is one. And what do I mean by that? Well, investment risk is simply choosing the wrong thing to invest in. For example, let's say that, Apple stock has done really well, obviously, over the last twenty years. Let's say we put all of our money in Apple stock, and then it goes to zero over the next ten years.

Well, that would obviously be a risky investment simply because it's one unique company. And so that is investment risk. What if we pick the wrong thing? Another common risk for investors is gonna be timing risk in terms of trying to time the market by getting in and out at certain points based on who the president is or what the economy's doing or what war is going on. And so we like to try to outsmart the market as humans.

It's our nature. And so that is a risk. I would say that trying to beat the market is a risk. Another risk is sequence of return risk. Meaning if you're retired, you're likely having to pull money from your investment accounts.

And so if the market goes down 30% and you then you have to pull out money from your accounts. Well, then you're taking it out at a low point, which means you have to sell at a low point, and then you're never gonna get that money back because you've already spent And then there's no way to earn that back. So sequence of return risk is a big deal. And that's assuming, you know, obviously if you're invested a 100% stock, then you can run into that issue. So those are a, a couple different risks from an aggressive standpoint.

Like you don't want to invest in singular companies. You don't want to put it all a 100% equities, because of sequence of return risk. And then you don't want to try to beat the market by getting in and out or trying to pick certain stocks. Those are aggressive risks that I I would say are there. Let's flip to the other side and talk about conservative risks.

Well, conservative risk could be, hey. I wanna have all my money sitting under my mattress at my house and not earning interest at the bank because I'm scared of banks. And so we can go super extreme and say, hey. I wanna have my money in my hand, in my house, in a safe. And so that is a risk because if you lose it, well, obviously, you're not gonna have it.

And the biggest risk there is probably, purchasing power risk, or some will think of it as, like, inflation risk. Every day, that cash is gonna be losing value. As we saw throughout 2022, inflation was around eight to 9% throughout that whole year. And so, basically, you lost 8% no matter what. You know?

That's the that's the issue with holding cash and holding too much cash is you are going to have, purchasing power risk of your money basically losing value. Another risk on the conservative side is if you do that, well, your chances of outliving your money become greater. Right? Because if you're not increasing the value of your money and you know that your cost of living are gonna be increasing over time, then you will run out of money if you live long enough. And so outliving your money or just living too long is a huge risk for someone who's super conservative.

And then in 2022, we saw something pretty unique where corporate bonds were down over 12% for the year because of interest rates going up. Therefore, the bond you bought last year, the value of that has gone down because I could buy a new bond today. Why would I buy your bond at a lower interest rate whenever I can buy a new one today? So you'd have to sell that to me for a discount. So that happened in 2022.

You know, investment grade corporate bonds were down around 12 to 13%, and which is crazy because the stock market itself was down 20%. So, bonds themselves are not, risk free, and we often think of them as a hedge or opposite of what stocks are. And so that is something that to be on the lookout for is is they're not actually as safe as you perhaps think. So, there's two kind of sides to it whenever we think of what was risky and what is not. Well, there's risks on all sides.

If you're too conservative, there's a lot of risk there. You could run out of money. You're losing value every day because of inflation. And then also the risk of being too aggressive is, hey. I don't have any money today to live on because it went down 30%, and I've gotta sell at a discount in order to create income for myself.

So we have to meet somewhere in the middle. So why does this matter to you as a retiree? Well, your time horizon isn't as short as you think it is. If you retire at 60 and you live to 90, well, that's thirty years. I mean, do you think about, like, how long that actually is?

You know, you you have a long time to actually invest and continue growing your money so that you don't run out. So the only surefire way to run out of money is to distribute it annually and not replace those distributions with investment gains. So what should you do? Well, you need to have an investment plan that is informed by your income needs. And so, more specifically, how much income you need to distribute from your portfolio, that should dictate how much you allocate towards each investment class.

And so here's how I do this with my clients. I create a three bucket retirement plan, and it goes as follows. The first bucket consists of cash and money markets. These are our very safe, conservative, assets that we need within the next two to three years. Right?

So at a minimum, I wanna have two years worth of living expenses sitting in cash in the bank or in an IRA, just not volatile. I don't want it to go up and down with the market. I want it to be there and ready to be used when we need it. Right? So I want a minimum two years of living expenses.

So for example, if you need to pull $50,000 from your investment accounts to live on in retirement, well, that means we need at least a $100,000 sitting in cash right now today, and that is not available for investing in either bonds or stocks. That is liquid cash that we can get to tomorrow. And then, obviously, that's a minimum, so we can have more than that if we need to, but two years worth of cash is bucket number one. And so this creates peace of mind knowing that regardless of the current economy or market conditions that you have, you know that you have enough money to live on for at least two years. Right?

So that hopefully gives you a little bit of peace and helps you sleep at night knowing that regardless of the current market cycle we're going through, you can actually live because you have the cash you need to meet your needs for at least two years at a minimum. And then, hopefully, by that point, we've we've either recovered a little bit or we've kind of made some strides on the other portions of your investment allocation. Now that leads us to the second bucket. Well, the second bucket consists of, at a minimum, three years worth of bonds, treasuries, or CDs. These are our kind of fixed income assets.

These are the things that will give us a little bit of return, but we're not really counting on them to really grow, substantially over time. And this is what I would call, like, a midterm kind of investment horizon, bucket because you're wanting to have them somewhat safe, but you want them to earn a little bit. Right? That's the point of the bonds, the treasuries, and the CDs. And it's still fairly liquid, right, because you can sell the asset and get to it, but it has a lot less risk than a stock market.

You know, the volatility of the stock market is the thing that scares people out of it most of the time. So having three years worth of bonds, treasuries, and CDs is important to kind of this three bucket retirement plans. So just based on these two buckets I've already explained, right away, we've got five years worth of living expenses in cash and bonds. And remember, these are minimum, so we could have more than that if we'd like. So the third bucket is anything that we would need beyond five years from now.

Right? This bucket is allowed to be invested in stocks for a long term growth kind of asset allocation. This is our growth bucket, and it's designed to beat inflation, designed to provide income for you in twenty years or after. And so by creating this three bucket retirement income plan, we're covering the short term, the midterm, and the long term needs, for you throughout your retirement. Do you notice what this isn't?

This is not just me recommending a certain asset allocation that follows, you know, retirement rules of thumb. This is a thoughtful way to create an investment allocation that is tailored specifically for you and your needs. Right? Because not everybody spends the same amount. So one person can spend $50,000 a year.

One person can spend a $100,000 a year. Therefore, their allocation is gonna be a different allocation because we're basing it on how much they're spending, not what we should just have rules of thumb. Oh, you should be $60.40. You should be $70.30. You should be $50.50.

That's not the way I do it. I like to make sure that the investment allocation we end up having for you as a client is ultimately informed and based on how much income you need. Okay. So here's an example. John and Mary, they've got a million dollars in retirement funds.

They need 50,000 a year from their investment portfolio. So, obviously, in bucket number one, remember, we need at least two years worth of cash. So we're gonna have a $100,000 at minimum in cash, which is bucket number one. Bucket number two, we wanna have at least three years worth of bonds, treasuries, and CDs. So we're gonna have a $150,000, remember, because they're spending 50,000 a year.

We're gonna have a $150,000 in, bucket number two. Anything else is allowed to be in stock funds. So right away, you can see one thing. If you add up bucket number one and bucket number two, that's a total of $250,000, and their total assets are worth a million. So right away, can say, hey.

This is a 75% stock and a 25% bond portfolio. And like I said, that is not necessarily the standard. That's not always what happens. It's just the way that this one works out based on the bucketing strategy. But now John and Mary can comfortably retire and live for five years without having to worry about stock market fluctuation.

And the reason I kinda choose five years is if we look back to o eight, it took from, you know, 2008 to 2013 to get fully recovered in the stock market. And that's kind of one of our biggest market events that we can go on. This is the financial crisis of two thousand eight. So that's kinda why I chose, like, this five year buffer kinda rule with the that bucketing strategy. Obviously, we can have more money in bucket number one or bucket number two, but five years is kinda like the minimum that I've landed on.

So, hopefully, you can see by having a three bucket retirement plan that is based on your income needs, we can basically say, hey. I don't have to be more conservative than I otherwise need to because I know that regardless of what's going on in the economy, the world, things like that, I I have at least five years worth of, quote, you know, conservative assets that I can get to, and at a minimum, two years worth of cash, which is not gonna go up or down. You might lose money to inflation, but that's okay because the value, the dollar amount is still there. Right? So having that that bucket strategy allows you, number one, to hopefully feel more at peace with the plan.

Number two, sleep at night just because you know, hey. If if the market goes down 10% tomorrow, like, that's fine. We know that the money that's actually going down to 10%, we don't need that for at least five years. And so having a three record retirement plan covers your short, your midterm, and your long term income needs. And this has been a super beneficial way for my clients to understand it, but also for me to help guide them through all the decisions that they have to make as a retiree.

So with that being said, here's a quick recap. As you enter into retirement, the main thing I want you to consider is not being too conservative or fearful. I get it. You know, this is the most money you've ever had. You're you're not gonna work anymore.

And so the fear that comes with not being able to earn an income is is sometimes overwhelming. And so what I suggest is so what I suggest is allow yourself to feel that, but then also come out of that and say, hey. I've gotta develop a plan that is based on my income needs so that I can weather any storm, both short term or long term, and then and then not miss out on my income needs right now, but also not run out of money for twenty or thirty years from now because I didn't invest it properly. So creating that three bucket retirement plan is crucial to having a successful retirement, and it allows you to not be overly conservative when you otherwise shouldn't have to be. So I hope this is helpful and kinda gives you a little bit of framework to go on as you begin to think about your retirement and kinda your needs that you have to meet.

But, once again, my name is Jacob Duke, and this has been Retirement Answers. I look forward to speaking with you again next week.