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4 Questions to Answer Before Creating Your Retirement Portfolio

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William Bernstein is a student of financial history. He generously shares investing knowledge through his writing and speaking. Such was the case when he was recently interviewed on Morningstar’s The LongView Podcast, promoting the release of an update of his investing classic The Four Pillars of Investing.

This interview packed a lot of wisdom into a relatively short conversation. There was one downside. The format didn’t give much time to zoom in on any one specific topic.

I would like to do that with one topic that is particularly relevant to readers of this blog. Bernstein briefly discussed four questions anyone approaching or in retirement should be able to answer to effectively build and manage their portfolio.

What is your burn rate?

I have a love-hate relationship with safe withdrawal rate research. On one hand, understanding how much you want to spend in retirement (NOT your income or a generic “magic” retirement number) determines how much you need to retire is foundational. 

Using the inverse of the 4% rule informs the idea that you need approximately 25 times your annual spending to be financially independent. While not perfect, this provides a true north to work towards during the accumulation phase which many people find motivational.

This also drives the behavioral change of increasing saving for many people. It also helps illustrate the impact of fees on a portfolio. This leads people to educate themselves on investing and take control of their portfolios.

However, no one actually spends money in retirement as modeled in this research. As you near retirement there are better ways to determine whether you have enough. Using professional financial planning software or outstanding options available to individual investors like NewRetirement PlannerPlus or Pralana Gold (affiliate links) allow you to model anticipated expenses and income streams in retirement. 

This is superior to assuming a constant rate of spending and a rate of withdrawal from a portfolio, adjusted only for inflation. However, Bernstein’s point is an important one.

You need to know:

  • What is your starting burn rate? 
  • How will it change over time?

The lower your burn rate, the less aggressive you need to be with your return assumptions. Simultaneously, a lower burn rate allows you to afford being more aggressive with your investments. The higher your burn rate, the opposite is true.

Understanding this will help determine how you answer his subsequent questions.

How old are you? (I.e. What is your time frame)?

It’s important to have a realistic expectation of how long your retirement will be. Your portfolio must find a balance to last through that anticipated time.

It must be conservative enough to provide adequate stability. You can’t draw down too large a portion in a market downturn early in retirement. Your portfolio may not be able to recover (i.e. too susceptible to sequence of returns risk).

Simultaneously, you must take enough risk to provide adequate growth. If you don’t, a combination of your withdrawals plus the impact of inflation will slowly erode your portfolio (i.e. – too susceptible to inflation risk).

Related: Investment Risk — What You Don’t Know Can Hurt You

It is impossible to know exactly the right mix of investments to have in your portfolio. However, recent research shows that self-directed investors hold a far greater percentage of their portfolio in stocks at retirement age than:

  • Target date funds that match their age.
  • Age matched investors with managed retirement accounts.

Anecdotally, this is a trend I see consistently in near retirees, whether FIRE types or traditional. It is concerning.

It is worth spending some time considering how much risk you have in your portfolio. Is it time to take some risk off the table if you are approaching retirement?

What is your risk tolerance?

Your burn rate and how long you need your money to last are considerations of your risk capacity. Risk tolerance is more of an assessment of how you will fare mentally. How would you feel in a time of market volatility?

Because you have a very low burn rate and/or short anticipated time to support yourself, you may have a very high risk capacity. However, if the portfolio volatility that accompanies it would cause you to lose sleep at night, what’s the point of taking unnecessary risk?

If you actually act on your fears during periods of market volatility, your secure position can suddenly become precarious. So you need to be honest with yourself.

How many past bear markets have you been through? How did you behave? 

Past behavior is probably the best indicator you can go on. However, it is not a guarantee of the future. 

In retirement you won’t have new money coming in to invest when stocks are “on sale” in a downturn. With larger account balances, an equivalent percentage loss will equate to a larger loss in absolute dollars. 

Both of these factors can drastically change the psychology associated with the same market event. Both are good arguments for being a bit more conservative as we get older.

This brings us to Bernstein’s 4th question.

How do you value safety vs. leaving a bequest?

This question applies to those that are confident that they have saved enough for a secure retirement, and likely have saved more than enough.

One way to consider this question is with a famous quote of none other than Bernstein himself. “If you’ve won the game, stop playing.”

What if you ran out of money in your 80’s? Or in the later stages of retirement you had to skimp by with limited options and not knowing if your money would last? How bad would that make you feel?

However, there is another school of thought. If you have both the risk tolerance and capacity, you can dial up the risk in your portfolio. Swing for the fences! If you have a low burn rate and non-portfolio sources of income (annuities, pension, Social Security, etc.) that cover most or all of your normal spending, this may be reasonable. 

What if at the end of your retirement you were sitting on $10 million dollars? Or more? Where would you want that money to go? Would it be life changing for you or people or causes you love? How good would that make you feel?

For most people, there is significant asymmetry. The downside of the worst outcomes is worse than the benefit of the best outcomes. If that applies to you, it’s a good argument for dialing back risk, even if it means you will likely end up with a smaller portfolio to bequest to others.

However, if you have both the capacity and tolerance it may make sense to take more risk…. Or better yet, just start giving the money away sooner. Then you can have more impact on the beneficiaries and enjoy seeing the impacts of your gifts.

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. Now he draws on his experience to write about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. You can reach him at chris@caniretireyet.com.]

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