Retirement Answers

Jacob: 00:00

Hey, friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke. I am your host, as always, here on the show. Today, I want to talk about a topic that it kind of comes to the forefront of every person's mind as they are about to retire, but maybe even more specifically during this particular moment in time because of the current market cycle we're going through, but then also a question I got recently from a prospective client. It is around the idea of what happens if I retire and then the market goes down 50% and then I cannot stay retired because I will be pulling from a portfolio that is now half the value that it was when I retired.

Jacob: 00:35

And so this thing called sequence of return risk begins to be a huge issue for me. What happens if that happens? Like worst case scenario, how do I combat that? Should I retire during a recession or a bear market? What does that look like?

Jacob: 00:48

And what are my risks? And so I want to address this kind of talk through it. I want to share two primary things that are really the focal point here that we've got to look at and think about. I want to give you a few different suggestions and ideas to think about in your situation that you can use to overcome this and hopefully prepare a little bit better for these different times that might come up. So let's say you wanted to retire this year in 2025, and it's March right now, and you're thinking, Hey, I want to retire by the end of the year, but the market's kind of going down.

Jacob: 01:17

That's something that's on a lot of people's mind. It's been going up for two to three, four years straight now. We've gotten used to really good returns, double digit returns year after year. We've kind of been lulled into this expectation of positive returns. And if you know anything about investing, know that is not the case.

Jacob: 01:32

If you've invested long enough, which most of you have, you know that the market has volatility. It goes up, it goes down. There are different cycles and seasons throughout this whole thing. So the big question or concern is what happens if I retire during a bad season or a bad cycle? So you're thinking about retirement this year and you see the market starting to decline.

Jacob: 01:49

In fact, the S and P as of the recording of this episode is down 10% from its all time high, and it's causing you to maybe reconsider. You're asking yourself, is it a smart move to retire? My portfolio is losing money. What happens if it keeps going down for the next year or two? You know, you've heard about Sequence of Return Risk and you feel like you could be exposing yourself to that without having to, if you retire at the wrong time or retire based on when you plan to later this year.

Jacob: 02:13

So what do you do? Two things are at play here. Number one, there's the financial reality of this. And the second thing is the emotional reality or the emotional side of this. Let's address the financial piece first.

Jacob: 02:24

So this is called sequence of return risk. Many of you have looked this up. You've heard about this. I've spoken on it before, and it's a common issue or I guess fear or concern for people that are in retirement, and it's a big one. And the reason for that is if you have to sell investments at a loss to create your retirement income, you are creating a negative compounding effect on yourself, and that could actually jeopardize your retirement success if you have to sell things at a loss for an extended period of time.

Jacob: 02:51

So that sequence of return risk. And so think about this, if you retire today and then the market is down or your portfolio has lost value for three years in a row, yet you still need a certain amount of money out of that portfolio to meet your income needs, then you're going to have problems, right? Because you're going to be selling things that have lost money in order to create that income. So you're essentially dwindling your portfolio at a much faster rate because your distribution rate has increased on the new sum of money because that is that sum has gone down in value. So that sequence of return risk, It's a big fear for a lot of retirees.

Jacob: 03:22

So don't think that you are alone and in fact that you are worrying about this. So that's the that's the financial piece. Now, the other side of this is the emotional side. And what I mean by this is what is your capacity emotionally to handle downturns whenever you're no longer earning an income? What is your capacity to withstand some loss on paper in your portfolio instead of actually panicking and selling and changing everything as I'm going back to work immediately?

Jacob: 03:48

All these things start to kind of come into your mind. Oh my goodness, I worked so hard for all this time just be able to retire and enjoy life and do things that I've kind of put off or waited to do. And now it's in jeopardy because I retired at the wrong time. So there's a there's an emotional component and a mental side of this as well. So those are the two things we've got to consider.

Jacob: 04:08

Now, what do I suggest or how do we combat this? Well, I've done a previous episode on this before, but there's something that I like to call the last five first five. And what that's referring to is the last five years of your working career, and then the first five years of retirement. That ten year window is huge. That ten year window is crucial.

Jacob: 04:28

Everything in terms of your retirement success, in my opinion, depends on that ten year window. What you do leading up to retirement, and then how you execute a plan in the first five years after retirement, that's gonna be the thing that sets you on the right trajectory, and it's gonna be the thing that determines whether or not you outlive your money or not, or leave a legacy to your family or not, or make sure your spouse is taken care of after you pass away. That ten year window, last five and the first five is going to be huge. So how do you use those years and what do you need to do correctly? Well, the first thing is, is you have to make sure you structure your portfolio the right way.

Jacob: 05:02

So what I've seen in conversations with people just like you every day that I have that call and say, Jacob, I think I might want you to help me with my different retirement plans and investments and things like that. What I've seen is as more and more people have been lulled into this aggressive investment approach or this aggressive mindset because of how good and how easy things have been to make money. Here's the reality, that is not always the case. That is not always that way. If it were always easy to make money, you wouldn't make as much money.

Jacob: 05:34

There has to be a risk component to investing and we're starting to see that a little bit. There has to be risk in order to get returns of great value. So the reason you don't earn a ton of money on your money market or cash is because it is quote risk free. Now there's inflation risk that's associated with it, but there's no volatility, and that's a different story, different episode between what is risk and what is volatility. And most people, you know, assume that those are the same thing, they're not.

Jacob: 05:58

But more and more people are taking a risk on approach simply because of how much money has been made over the few years and some people have missed out on that. So they're getting in now or maybe they have their own personal biases politically or whatever it might be to get in or get out because of someone that's in the Oval Office. And so what we have here is we have this misunderstanding of what your portfolio should be based on your risk exposure as you approach retirement. So how do you structure a portfolio in the last five years of retirement? Well, five years out, you might not need to be exactly how your portfolio would be in retirement, but you should be starting to get closer.

Jacob: 06:35

And so here's what I mean by that. Whenever I approach retirement allocations for my clients, what I do is we use a bucketed strategy. So I use a cash bucket, a fixed income bucket, and then a stock bucket or an equity bucket. And so I've done episodes on this, but it's a three bucket approach. We make sure we have enough cash to meet at least two years of our living expense needs in bucket number one, we want to have at least three years of living expense needs in bucket number two, that would be your fixed income buckets.

Jacob: 07:00

So think like US Treasuries, some corporate bonds, some other fixed income that might be mixed in there as well. And then anything that you would not need at least for five years is allowed to be in stocks. Okay, so that gives you a five year runway of quote conservative assets. And what I mean by that is they are not as volatile in the short term, long term, they actually become more risky because their rate of return is a lot lower than stocks. Again, different story for a different day.

Jacob: 07:26

But you've got to have that runway in order to sleep at night and then not have to sell your stock positions during moments like this. If you were to retire this year in the markets down 20%, if that's what ends up happening here, you don't want to have to sell stocks at a 20% discount in order to create income for yourself. So you have to have this runway. That's why the bucket approach is so crucial. And also the buckets are crucial from a long term perspective as well, because one of the things that a lot of people end up doing is they get really conservative as they enter retirement because they can't quote, lose all of their money because they need it to live.

Jacob: 07:59

And so that's a fair statement, right? We do need that money to live. But what happens is we get really shortsighted because we get overly conservative and say, I don't want my money to go up and down. I want it to be a flat line. I don't want it I just don't wanna see anything getting lost anywhere.

Jacob: 08:13

And so what happens is people get overly conservative, which jeopardizes the back end of their retirement rather than the front end of retirement because, they're now subject to inflation risk. They're subject to many other things because their portfolio is not outpacing the cost of living as it should be because there's minimal long term risky assets that could outpace that inflation in the portfolio. So there's two sides of this, and that's why I like the bucketing strategy. So I require at least a minimum of five years of income in bucket number one and bucket number two combined. Obviously, we can have a little bit more than that up to a certain amount if we want to, but there's a happy medium there.

Jacob: 08:44

And so what that does is, is that does not necessarily follow a standard retirement portfolio or a cookie cutter approach. What that does is it tailors your investment allocation to your specific income needs rather than just saying, hey, be fiftyfifty or sixtyforty without having any justifiable reason for that. So going back to why this is important as you approach retirement, what this does is, is this helps you almost start living and thinking like you are retired. And so your allocation is a part of that. You're not trying to make a ton of money here.

Jacob: 09:16

Okay, you're not trying to make a ton of money in these last couple of years, because if you are, that means you probably aren't ready to retire. Okay, if you have to push the dial and say, I'm gonna max this thing out and see what I can get to see if I can retire in two years, you're probably not doing something right, or you're probably not ready to retire. You have to have a little bit of margin and wiggle room here. Most people that are successful could have retired years ago, okay? Means there's enough margin to withstand these downturns.

Jacob: 09:43

So you've got to get your portfolio ready for retirement before you actually retire so that you can start living as if you retired and you can make sure that you are positioned in such a way that if a downturn happens year one of retirement, you have a portfolio that's ready to sustain and withstand that because it's been prepared that way in advance. So don't wait to reposition your portfolio until you retire. You got to do it before, because an improper allocation, it could force you to do many things out of order that you don't want to do. For example, if you retire at 60 and things go down in South for a year or two, it might force you to take Social Security at 62, and that might be before you wanted to, you're gonna have to take a 30% discount on your benefits for the rest of your life, and otherwise you were planning to take them later so that you can maximize how much you get out of Social Security. But because of an improper allocation on the front end, you've kind of tied your hands behind your back and you really don't have a choice because you've dwindled your portfolio too quickly, had to sell things at a loss, and now you have to have Social Security to make sure your portfolio doesn't run out of money too soon.

Jacob: 10:44

So that's the the negative impacts of not thinking about this beforehand and getting structured correctly. Now, the next thing I want to say here is that market volatility is normal and it's expected. It should be expected in your mind. If you want to get the returns that you want to get, then you have to withstand some short term volatility. These types of things, they have to be expected and you have to be able to mentally prepare for it and you can't expect things to always go as you plan or go really well.

Jacob: 11:09

So remember that volatility, it's a part of it. You can't find a way out of it. There's no shortcuts in some sense. If you really want to make the money, there's always gonna be volatility involved. Again, this is why you have to have that bucket number one and bucket number two, in order to withstand that and have that sleep at night factor, so that you can avoid making any irrational and emotional decisions that would jeopardize things long term.

Jacob: 11:30

The next thing I would say to do is really examine your biggest expenses, like what will they be retirement? Are you gonna have a mortgage? Are you gonna have a car payment? Do you have extra credit card debt or HELOC or something that's really increasing your spending for every single month? And if you can find a way to reduce or minimize that, can you pay that mortgage off?

Jacob: 11:48

Can you pay the car off? Can you pay the credit card or the HELOC or whatever it is, the things that are causing you to spend a lot of money every single month that are fixed that have to be paid. Can you find a way to eliminate that so that you don't have to spend as much money, which means you don't have to sell as much out of your portfolio to create income for yourself. Because those big expenses, those are the things that really hurt people. My honest belief on this is if someone can enter retirement without a mortgage, they're pretty much guaranteed a successful retirement because everything else from that point outside of normal bills, just like electricity and water and food and gas, like those things can somewhat even be controlled a little bit.

Jacob: 12:23

Everything else is variable spending. It's discretionary, meaning if you have to, you can pull it back for the most part. So you can live pretty frugally if you don't have these large fixed expenses such as a mortgage or car payment or HELOC or some sort of debt that you've got to pay off. So evaluate what your big expenses are as you get close to retirement, say, how much risk are these actually to my retirement success? If a market downturn happens of 30%, my portfolio value goes down by 30%, What happens to the mortgage?

Jacob: 12:51

Can I still pay it? What happens to the car payment? Can I still pay it? What happens if I have a $100,000 car that I bought with cash even? Should I sell that in order to get some more liquidity and buy a $40,000 car?

Jacob: 13:04

And so now I have, you know, some liquidity to work with to help outlast this bear market. That's some things to think about. You got to think about repositioning your assets, perhaps to recapitalize in a way and then even bring up to yourself, like if I have these things on my balance sheet that I've got to pay and there's no way for me to pay them off currently right now today, you've got to ask yourself, is retirement a must? Like, do I have to actually retire, especially if things are not going well in the stock market? Maybe you'll have to work just a little bit longer to outlast that from a financial perspective, but even more importantly, in my opinion, outlast it from an emotional perspective, because what's the point of throwing yourself into something that creates emotional distress if you don't have to, okay?

Jacob: 13:47

Now, if you're like, hey, I've got to retire, there's health reasons, or maybe I'm being let go, or they're asking me to retire, or there is some sort of severance package or payout, I've got to take it. And you do have debt or you do have some of the things on your balance sheet. What if you sold the house to create more liquidity and rented for the next few years? Or what if you sold the expensive car to buy a cheaper like? What can you do to reposition things to help retirement happen more smoothly, especially if you have to retire for different or various reasons?

Jacob: 14:17

So get creative, maybe get creative on what you can do around your large expenses if they are still there. If you're paid off on the mortgage, if you're paid off on the house, have no debt outside of that, then you're in a really good spot. And that's again, one of the biggest determinants of someone being able to retire successfully. Now, here's the reality. It definitely helps to retire during a good market because it just eases the burden.

Jacob: 14:40

It eases the emotional pain that could be there. And what happens in the first, again, first five years of retirement really does set you on the trajectory of your retirement success and your retirement fulfillment. If you can retire during a good market cycle, then you're that much more ahead. But that does not mean that you cannot retire during a bad one if you're prepared. So following that portfolio structure, making sure you're investing as if you're close to retirement or already retired as you approach it.

Jacob: 15:07

If you're looking two to three years out, then I would start really getting your portfolio more aligned with a true retirement based portfolio. That way you are not exposed year one or day one or even if I was going to retire later this year the market's down like it is, and it keeps going down, and I'm exposed to that, well, then you could be jeopardizing your retirement because you didn't prepare adequately. So here's maybe a big takeaway. Here's what I would say overall. Start living today like you're retired before you actually retire.

Jacob: 15:35

So that can be on like the personal side of things and like your lifestyle. So go on the trips, go on the vacations, like pick up the new hobby, start playing more golf or pickleball or whatever, like your thing is that you think you want to do. Start doing that, And then you'll find out, do I actually enjoy it or do I not enjoy it as much as I thought I would? Right? So that could change your perspective around your lifestyle and retirement and say, wow, retirement might not be exactly what I thought it was going to be because I thought I was gonna play golf every day, but turns out I'm not good at golf and I don't like it when I'm not good at something, and so I don't wanna play golf all the time.

Jacob: 16:06

And so that's something to kind of test out, test the waters before you jump in feet first. Another thing that you need to do in terms of living as if you're retired goes back to your allocation and your investments, make sure that your portfolio starts to align with how you're going to have it allocated in retirement, because you're not focused on extreme growth anymore. You're focused on preservation through consistent growth. Okay, so the word preservation there, don't get that confused with conservative. There is an element of conservativeness within a portfolio as I referred to earlier, but you have to continue to grow a portfolio in order for it to be preserved over time.

Jacob: 16:42

Okay, you've got to again, outpace that inflation factor, so that you don't get caught twenty years down the road saying, my portfolio hasn't grown at all. And now things are two times or three times as much in terms of cost, long term care facilities are four times as much. How am I going to pay for that? I don't know, because I didn't invest correctly for the last twenty years. So you have to get your mindset around your investments to shift just a little bit.

Jacob: 17:02

You got to go from this extreme growth mode to preservation through adequate growth, and that has to shift over time as you approach retirement. So if you're having to push that envelope, like I referred to earlier and say, I've got to keep my risk profile high in the last couple of years to be able to reach a retirement number, then you're probably not in a position to retire because again, you're overexposing yourself to the unknown risks of market declines shortly before retirement or shortly after retirement, because you've done everything you can to like squeeze yourself to get to that retirement number because you've had to take so much risk on. You've got to dial the risk portion of your portfolio back at the right times to eliminate that sequence of return risk. So I know that this is a big topic right now because the market's going down for once in the last couple of years, we've seen 20 plus percent returns in the last two years, we did have minus 20 or so in 2022, and then 2020 and 2021 was actually positive as well. So returns over the last five years on average have been wonderful.

Jacob: 17:58

Is that going to be the case for the next five or the next ten years? I don't know. I believe in the reversion to the mean. I believe that things come back to the average and the average is what it is for a reason. And so it would be fair to say that maybe an expectation of lower annualized returns over the next five years is maybe something that you should probably start expecting.

Jacob: 18:16

So just remember this, prepare your portfolio before you get to retirement rather than waiting until the day of, because things might not work out that last year before retirement and ultimately force you to delay or continue working. So let me know your thoughts. Shoot me an email if you have questions on this or if there's something else maybe you thought should be added here. Happy to have a conversation with you. And if you're looking for someone to help you with your retirement planning, then go ahead and click on the link down in the description below where you and I can have a one on one conversation.

Jacob: 18:42

It's completely free see if what we do here at River Tree is something that you could benefit from. Thanks so much, and we'll talk to you again next week. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode.

Jacob: 19:04

I look forward to talking with you again next week.