Investors who enter retirement without a well-thought-out plan risk making bad investment choices, paying unnecessary taxes or running out of money in retirement. Sometimes the self-made plan will fail to provide the financial success retirees sought.
As a financial adviser, I find most retirees have the same goals:
- Ensure their incomes will last for as long as they do and will increase as the cost of living increases.
- Protect their savings from unexpected health care costs, including long-term care.
- Reduce tax liability in retirement.
- Increase their wealth and pass as much as possible on to the next generation, without taxes taking too great a bite out of it.
Pursuing these goals requires a solid plan, one that can be established with the help of a financial adviser. Should you choose this route, the first step is to make sure the adviser knows as much about you as possible. What are your interests? What is your lifestyle? And, perhaps most important, what kind of investor do you want to be?
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By establishing well-defined objectives, you’ll be on your way to achieving the financial success you seek.
A Purpose-Based Plan
Creating a good plan includes setting clear objectives and aligning them in a customized strategy that targets each of these goals. There is no one-size-fits-all in retirement.
Know why you’re investing, and then determine what kind of investor you can afford to be. The choice to invest conservatively, moderately or aggressively should be based on your ability and objectives, willingness and need to take risk.
Conservative investors look to reduce risk by placing their money in investments that offer more protection and reduce volatility.
Moderate investors are willing to take higher risks.
Aggressive investors can take risks — either because they know their pension and other income will meet their lifestyle needs, or because they’re a ways away from retirement and have a longer time frame to recover any losses.
Imagine a pie cut into three slices with the size of each representing how much of your portfolio you will need to meet each goal.
The first slice represents the inflation-adjusted lifetime income you will need. Investments in this slice should have the lowest level of volatility. Investments in the second slice should be allocated based on your medium-term goals. Consider allocating the funds in the second, moderate slice for lifestyle choices and wishes, such as travel, desirable (but not must-have) purchases or charitable donations. The third slice would then serve building your wealth not only for you, but also for the future generations. This third slice could be invested more aggressively because you can leave it invested for a decade or two. Of course, tax-efficient strategies that reduce tax liability should be in place in all three slices.
The purpose-based plan challenges the Rule of 100, which many advisers continue to use.
Rule of 100
This long-standing rule of thumb suggests that a retiree of age 65 should place 65% of their funds in investments such as bonds, leaving 35% to be invested in equities. This would change as the retiree grows older, 70%-30%, 80%-20%, and so on with the level of risk dropping.
This approach sounds simple enough. But what happens if the majority of a retiree’s investments are in bonds, and the interest rate increases? In that situation, bonds will lose value.
That kind of scenario is why it’s important to have a plan that also offers flexibility.
Most people don’t have a plan, some take unnecessary higher levels of risk than they should, while others miss out on the potential gains by investing too conservatively. Meeting with a financial adviser, someone held to a fiduciary standard who is legally obligated to act in your best interests and who will establish a plan customized to help you work toward meeting your needs and desires during retirement is likely to increase chances of success for achieving your goals.
Daniel Shub is the founder of OCTO Capital and Shub & Company. Daniel holds the Registered Financial Consultant® designation, has passed the Series 65 securities exam and holds a Michigan insurance license.
Rozel Swain contributed to this article.
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