The newly retired, now without a salary, often find themselves terrified of the new financial arrangement. In my career as a portfolio manager I came across many different types of retirees, so I had the opportunity to observe the manner in which many managed their retirement lifestyle. A minority enters into retirement with beautifully constructed financial blueprints, but unfortunately, far more possessed little idea of what life faced them. I always thought it odd, as the vast majority of my clients were highly educated individuals coming from completion of successful careers, that so few planned it well. All walks of "moneyed" retirees came into my office. Although I was not, nor have I ever been a "financial planner", but rather a portfolio manager, whose time was largely spent in the equity side of investments, I was nonetheless frequently requested by the client to participate in their overall financial picture. Below are detailed a few of the struggles that I witnessed that caused financial ruin, and sad to say, one that ended in suicide.
The poor habit of spending money for whatever the couple wanted to do, with little regard to the depletion of their assets, was a frequent problem. They usually fell into the groupthink that just because they had several million dollars, they could survive forever on those funds without worry. Taking trips around the world presented no problem. Buying a new sports car every 1-2 years was a need. Eating in expensive 5 star restaurants 4-5 times a week was a ritual. Owning an expensive house on the water with a huge mortgage, even though their previous home had been free and clear of debt, caused little concern on their part. Despite my warning and counselling, the spending often continued. Finally, it dawned on most of them that they had spent too much and it became evident that they might not have enough without serious changes to spending habits. Most often, a house was sold, cars were kept longer, and general spending was curtailed, leading to a subdued retirement that was not envisioned.
A Plan, But Did Not Account For The Once A Year Expenses
Many couples had a reasonable idea of their month to month expenses. They withdrew income from their account on a monthly or quarterly basis and went about their retirement life. However, these good folks failed to take into account the expenses of such things as annual insurance bills (car/home), annual real estate bills, and even quarterly income tax payments. For those they would call for extra funds to pay those bills, which usually meant having to sell assets to raise the funds, which obviously led to reduced monthly income. This was often offset by a bigger annual withdrawal from an IRA. Furthermore the infrequent expenses of new cars or house repairs, were a common "unexpected" expense. Again, assets needed to be sold to pay for these, and income was further reduced. As long as they enjoyed good strong bull markets these good folks usually did ok, but sadly, not all markets are bull markets.
Proposed solution for the preceding examples
I think that these can easily be solved by the individuals making an honest assessment of their spending and then making themselves submit to a budget. And then, and only then, invest their funds to augment Social Security and any other income sources such as pensions, fixed income, or annuities. If one follows a dividend portfolio, then they know the income that they have to spend. I suggest that the following stocks be a part of that portfolio.
Core Holding For A Dividend Portfolio
|Johnson & Johnson (NYSE:JNJ)||103.5||2.72|
Procter & Gamble (NYSE:PG)
|Philip Morris (NYSE:PM)||85||4.41|
|General Electric (NYSE:GE)||26||3.4|
|Southern Company (NYSE:SO)||44||4.75|
Of course, I do not consider all of these securities great buys at the moment, but I do find Wal-Mart, General Electric, and McDonald's to be better valued ones at present. A long-term view should be taken with all stocks, but the idea is to maintain good quality and live within the dividend income. One can easily "spike" the income by weighting issues with higher yields (utilities & telephones) more heavily.
Why Should I Live On 4% If The Market Averages 10% A Year?
The above title is one of my favorite quotes and even earned me a nickname from a client. These clients point out that studies have shown that the market rises 10% (pick a number) over time and therefore that is what they insisted on spending. My example is a true story, but I will change the facts and figures to protect the "innocent". The subject always came around to his spending 10% a year from his account, as that was the historical stock market return. I usually told him why it would not work. First off, I would ask him if he suffered any effects from inflation and how he handled it? His answer was usually not yet, but when it does then I will just withdraw a bit more.
So finally one day I gave him the back-to-back bear market story. Suppose, I told him, that one is withdrawing 10% from $1,000,000 each year. Then I ask him if he needs just 10% or the dollar amount of $100,000 regardless of the actual return. The sheepish reply of course, is that no, I need the $100,000 since that is what I need for expenses. So I remind him of the bear market of the early 1970s and showed him how back-to-back bear market, coupled with his withdrawals, lost all his funds within six years. For that he nicknamed me "backtoback". He however, continued to withdraw his 10%. Years later, we had three back-to-back bear markets in the early 2000s. His widow returned to the workforce.
If one decides to base their income on a set withdrawal rate then something in the 3.5-4.5% range should be the upper limit for normal retirement age. The portfolio should have some steady growth prospects and be well balanced. An easy way to invest is to simply construct a portfolio of mutual funds or ETFs. For such an account I suggest a well-balanced fund allocation strategy around different areas of the market by percentages. Withdrawing a percentage amount is less complicated using funds to augment the income distributions. The following example is an all-equity portfolio.
Set Withdrawal Account
|Large cap stocks (S&P 500)||50-60%|
|Mid cap stocks||20-30%|
|Small cap stocks||10-15%|
|Foreign stocks/Developed & Emerging||10-15%|
I Don't Wish To Take Any Risk
This client thinks the stock market is fixed. In other words, they only want fixed income investments. While this was an acceptable strategy in an environment of higher interest rates, it has only led to reduced income flows over the last 30 years of declining rates. The late 2000s crash finally nailed the coffin shut for many of these investors as they could no longer survive on such low rates. Still risk averse to the stock market, in fact more so after a devastating bear market, they simply spent more and more of their remaining assets, if any, to survive.
If one falls into this category in today's market, at least they are in at a very low interest rate, so the income should not drop much from these levels.
From my experience the different scenarios listed above are the major issues that destroy retirement finances. Some other observations are poor planning of budgets, panicking during bear markets, greed in bull markets, and surprises that find no unexpected back-up plan. From my life experiences, and from my own personal experience gained in a few years in retirement, I offer some solutions to avoid the pain of spoiling one's golden years.
- Determine your income needs by thinking long and hard about a budget. Not just by looking at one's check-book over the last year, but planning a detailed budget such as found in this article. I have found that in my retirement, due to my detailed budgeting, (heck, I even budget the cost of my annual TurboTax software) that I have had zero unplanned expenses that caused any problem. In fact, I have already had some totally unexpected expenses that would have taken me down a notch without my planning, but I was able to sail through without a hitch. Hint, hint. Think kids. Think house. Think boat, (what was I thinking?). Over budgeting is a good thing!
- Balance an investment portfolio with other income sources, such as pensions and Social Security. Make sure that those fixed sources could carry the day if necessary. Each of us will look at their investment in a different light, some will rely on dividends, and some will rely on some fixed withdrawal rate, some on a combination of stocks & bonds, others on a combination of growth and dividends with an allocation to fixed income. Whatever the plan, work it.
- Be careful how a portfolio is structured. Allocate in most, if not all economic sectors within a range of 50-150% of each. Some sectors that have a very low percentage, such as electric utilities or transportation could go to zero without causing any disruptions. It is usually better to stay with quality issues like Procter & Gamble, Johnson & Johnson , AT&T (NYSE:T), and other dividend champions for both dividends and growth. Avoid investing with your heart and do it with your head. Avoid at all costs, tips from any source. Above all, learn to do it yourself, not depending on others to do your work for you. Make a plan, and largely stick to it. Adjust as needed. Investing basics is not rocket science.
- Plan for the unexpected. A large percentage of us will require some type of care toward the end of our lives. Explore purchasing Long Term Care insurance. Plan for the unexpected hurricane, flood, tornado, earthquake, or winter storm.
It is my hope in writing the article that the reader gains some food for thought in planning their retirement. If one is already retired, I hope that you see yourself on the good side of planning, and do not recognize yourself on the problem side. May good luck be with you, and I hope that this article finds you in good health.
Disclosure: The author is long JNJ, PG, MCD, COP, CVX, SO, VZ, GE, PM, WMT, CSCO, T.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.