Too many investors think they should switch to overly conservative investing after they retire. Some mistakenly move too large of a portion of their money into fixed-income investments and cash.
It is surprising that so often, people think they will live to the average age of the population, or until around 77 to 80 years. What they don’t realize is a key concept called “given or conditional probability.” Given that you are already over 60, the reality is that you have a new average life expectancy.
After all, you survived all those wild years of your youth. Hence, if you and your spouse already in your 60s, thinner than me, don’t smoke and have no major illness, guess what? At least one of you is more than likely to fly by 90 years old. That means your money has to last for 30 more years! You need your money to keep growing after you retire. And remember, you don’t want to run out of money six months before you pass. You have to make sure your money lasts longer than you.
What’s the remedy? It used to be that if you just left your money in the bank and bought some bonds, you could be assured of growing your money at 4 or 5 percent a year. However, those days are long gone, especially when inflation is factored in.
Naturally, you may say to yourself, “I don’t want to risk losing my money. After all, I can’t make it over again.” What can you do to grow your money at an average of 4 to 5 percent a year while keeping your risks low? The secret lies in getting the right asset classes in your portfolio and then leaving it alone. There is no such thing as a no-risk investment. But it turns that a broadly diversified portfolio left alone to grow for decades can allow your money to grow, yet as a whole, it can be just as safe as if you left it in the bank. But how do you make sure you get the mixture right?
Three components to diversifying your portfolio to long-term safety are needed.
Get a very broad mixture of assets. Make sure to have small portions of many different asset classes and management styles in your overall portfolio to smooth out the volatility over time. Although much attention is given to trying to pick the best-performing funds, it turns out that better long-term growth at reduced risk comes more from good diversification rather than fund selection. This mixture of assets should include all levels of equities, large-cap, small-cap, various industries, different styles, both active and passive funds, plus a variety of corporate and government bonds, mixing short and long-term duration. Make sure to include other asset classes like real estate investment trusts and even a dose of a variety of commodities, from timber to gold to oil and gas. As you age, you will very slowly reduce portions of the higher-volatility asset classes; for instance, larger blue chip stocks with higher dividend yields will replace the small-cap, more volatile growth stocks. Still, the secret is not making too big of a bet on any one asset class or style.
Broaden your horizon of countries. Despite the massive economic improvements of many countries around the world, the news still scares many away from investing overseas. Yet one of the most important ways to decrease your portfolio volatility while increasing your return is to make sure to have a significant minority of your assets invested in highly rated overseas securities. The reality is that growth in the U.S., Europe and Japan is slowing as our populations age. But the good news is that there is a select group of about 20 countries, including Chile, Poland and Thailand, that have already emerged and they will continue to grow at a rate much higher than the “old countries” and yet, as a basket, will be diversified enough to keep your volatility relatively low. In your retirement years, it is best to stay out of the more “frontier countries” as they remain too volatile. However, the safer portion of the “growth countries,” as a whole, could actually turn out to be safer than just investing in the U.S. It’s fine to have the majority of your money in the U.S. in the 21st century, but it is no longer wise to have your entire core portion invested in only one country.
Let time work its magic. Of all the diversification techniques you can employ, time, by far, is the most powerful. Indeed, we have seen again how much patience matters. In the crash of 2008, if you only took out enough money that you would need to live on, for instance, one-thirtieth of all your money, then you would have only suffered a loss on that small portion. And after only five years, the various markets have recovered. Thus, only taking each year what you need to live on is critical. Of course, you may slowly reduce first from the more growth-oriented volatile asset classes as you age, but remember, at least a significant portion of your money needs to keep growing even into your 80s.
What should the non-cash portfolio look like when you’re 72?
|Sample Recommendation for a 72-Year-Old Person|
|International equities (including growth countries)||5-10%|
|Fixed income, U.S. – government and corporate||40-55%|
|Fixed income, international bonds||5-15%|
|Real estate investment trust funds||3-8%|
|A mixture of commodities||2-4%|
Naturally, every person is different. Needing to spend money sooner for your own unique reasons alone can alter these percentages dramatically. Thus, a range of suggested portfolio weightings is much more helpful. The portfolio below is stated in wide ranges because as you age, you will want to move to the lower percentages of investment in these classes and more into cash and short-term funds. Just remember to do it slowly – only a little movement each year.
Understandably, people will have their personal prejudices against certain investments. However, it is critical not to totally ignore any category. Having zero money invested overseas, for instance, actually adds risk to your portfolio.
For many people, their home is one of their most important assets. But remember, you have high concentration and liquidity risk in your house investment, so it is best to make sure you have a solid investment portfolio in financial assets as well.
The above portfolio structure will help ensure that no matter how long you live, you won’t be a financial burden on your family.
Tim McCarthy is the author of "The Safe Investor," released in February 2014, and former chairman and CEO of Nikko Asset Management Co. He has also worked at other large financial institutions such as Fidelity Investments and Merrill Lynch.