If you’re like most investors, you’ve focused on making money for most of your financial life. But once you’re retired or close to retirement, I believe you need to shift gears, to put protection ahead of growth in order to make your savings last.
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In other words, I suggest you should only take as much risk as is necessary to accomplish your financial goals.
Calculate How Much Return You Really Need
Let's say you’ve done extremely well with your savings and investments over the years. You have $10 million in savings and live on $100,000 a year, so your cost of living is basically 1%. If you earned just 1% on your money, you’d never tap into your nest egg at all. I’d say you’ve won the game, and that you shouldn't risk that win. If you were the coach of a football team that was ahead by 10 points in the fourth quarter, would you tell your players to do anything that could cost you the game? I wouldn’t, and I’d say the same to an investor.
If you have $10 million and only need a 1% return to support your lifestyle, I believe you should have no stock market risk. At that rate, you could probably put your money in a savings account and make enough to support your lifestyle.
It can be tempting to take a risk, especially when the market is bullish, but let me ask you this: If I could somehow guarantee you that a 2% rate of return would keep you financially secure for the rest of your life, would you take that rate — even if it didn’t beat the S&P? I think most people would take that deal and be really happy that they never had to worry about money again.
That’s why I believe that your retirement income is more important than the percentage return on your money.
What If You’re Not as Well Off?
But what if you only had $100,000 saved and you needed $10,000 a year to support your lifestyle? That would mean you needed a 10% rate of return. Would I advise you to chase a 10% return? No. I’d argue that that there’s no way to get that rate consistently.
Yes, the average annual return for the S&P 500 since its inception is 10%, but once you adjust for inflation, the average drops to around 7%. And there’s a bigger problem: That rate is an average from 1926 through 2018. The rate is nowhere as consistent in smaller increments of time. The average rate of return in 2007 was just 5.48% — and in 2008 it was -36.55%.
And to reiterate the point of this article: If you chase high returns, you are taking high risks. When you were working, you might have been able to cover some of your losses with your salary. But once you’re retired, you’re not just risking your nest egg: You’re risking income that helps to cover your cost of living. You’re running the risk of becoming poor.
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Two Options to Address Your Shortfall
Since attempting high returns is too risky, what can you do to make ends meet in retirement if your savings are falling short of your spending needs? Before you consider amping up your stock market risk to make up for the shortfall, first I’d suggest you take a hard look at your expenses instead.
Cost-cutting is difficult for most people. The term implies eliminating something you do—and probably do for enjoyment rather than necessity, or else it wouldn’t be on the table as a cost-cutting option. Instead, I advise people whose lifestyles outstrip their financial capabilities to reduce quantity. For example, I don’t suggest they stop playing golf, but cut back from playing from five days a week to playing three. If they’re eating out three times a week, I suggest they dine out once weekly.
It makes sense: If you want to lose weight, you don't stop eating, you just eat less. This “reduction in quantity” is the same sort of idea. If you manage quantity, the expenses will take care of themselves.
And if cost cutting doesn’t get you far enough? Well, there’s another thing you may need to do: Consider working longer, or, if you’re already retired, go back to work.
A Different Way to Think About Retirement
If you think my version of financial planning for retirement looks more like cash flow analysis than a typical investment plan, you’d be right. My job as a financial adviser is to help my clients’ money last as long as they do. I think that’s your job as an investor, too. And I think the best way to do that is to take only as much risk as you need to support your standard of living.
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Ken Moraif, CFP, is CEO and senior adviser at Retirement Planners of America (opens in new tab), a Dallas-based wealth management and investment firm with over $4.3 billion in AUM and serving over 8,000 households (as of May 2019). He is also the host of the radio show "Money Matters with Ken Moraif," which has offered listeners retirement, investing and personal finance advice since 1996.
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