Over my 30 plus years in portfolio management I have witnessed three different types of retirees. I have observed the good, the bad, and the ugly behavior of managing one's retirement finances. In this article I will point out the differences of each.
The Good: This individual or couple has a goal in place. They live on a budget, limit their spending to an income flow, and control their emotions during times of market turbulence.
The following are five characteristics of this retiree:
1. A budget somewhat like the one here.
There are cases in which they might raid principal for special occasions or unexpected conditions, such as a child losing their job, but not for ordinary expected expenses. House maintenance, such as new roof, is included in a yearly budget plan. Funds, not included for income, are reserved for out-of-the-blue emergencies. They usually produce more income than they spend.
2. A portfolio that is income driven with a balance between stocks and bonds. Many have a portfolio of only stocks, however, they are the ones with more money than they could ever spend. I have found that these are the retirees that detest bonds, preferring the growth and income derived from dividends. They were Income investors before the term dividend-growth investor was popular. A sample portfolio from my sector to sector series of articles is here.
3. An estate plan is in place to include an updated will, and perhaps several trusts set up for family members, especially for a spouse or children that they feel are incapable of managing an inheritance. Those few that have family members with special needs always have a trust in place to provide for their long term care
4. Low turnover. Often this investor will have no equity trades during the course of a year, There might be a buy or two if accumulated income is not needed for expenses. The portfolio is composed of low cost positions held for many years.
5, They take a calm cool approach, like that of 'the good" played by Clint Eastwood in the movie "The Good, the Bad, and the Ugly". When markets tank they do not panic by calling their portfolio manager demanding changes be made to their portfolio to reduce market risk. Instead, they make comments like, a) what goes up might come down, b) are there any good buys?
The Bad: This retiree has an idea of what is spent, but not closely defined. They tend to overreact to market movements making poor decisions thereby causing turnover that harms their investment performance.
1. They do not have a budget, but have a general idea of their monthly expenses. They withdraw a set amount each month to cover expenses. They start out spending income, but before the year is out they are withdrawing additional funds for a new car, or a new roof, or for an annual insurance premium. During years of great markets they continue their spending with little regard for future downturns.
2. The starting portfolio is a mix of stocks and bonds, but they spend all of the income leaving no room for the unexpected. They are familiar with the 4% withdrawal rule but it is all show, as they may withdraw 4% on a monthly schedule, but withdraw for extras, which they do not include within the 4% budget. The portfolio is under constant stress due to sporadic spending. The 4% withdrawal often swells to 5-8%, often much more in any given year.
3. Estate planning is usually in place with an updated will and perhaps trusts for the future. They do not concern themselves with building the living bridge found here as they intend on leaving whatever they do not spend.
4. Turnover is higher than the "good" investor, as they must rely on capital gains to feed their expenses. Income is never enough to cover expenses so any temporary loss of capital causes panic on their part.
5. This retiree thinks they can time the market. Unfortunately, they usually sell after the majority of the decline has taken place and chase stocks at the top. They shift the investment objective based on what has happened recently rather than focusing on the long term trends. Panic is the rule of the day rather than a calm focused strategy.
The Ugly: This retiree cannot even spell budget. They spend without regard to the consequences and portfolio turnover is high with many directed speculative investments.
1. The ugly spend whatever they feel like as they think that several million will last their lifetime regardless of expenses . This retiree cannot say no to any desires such as expensive trips, cars, homes, boats, restaurants, or social clubs. Many frivolously spend their own assets knowing that an future inheritance will bail them out. My observations have been that the future inheritance is often less than expected, or arrives much later than needed.
2. The portfolio is usually a mix of stocks and bonds, but they feel that it must be constantly traded in order to avoid every decline. They usually raise cash at the bottom and become bullish after long rises. The ugly are buying the latest hot tip of some unproven product with expectations of becoming the next Google (GOOG) or Microsoft (MSFT). Without fail, form my experience, they all become worthless investments.
3. This retiree will likely have a will and estate plan in place, but it is not a top priority in his life.
4. High turnover is the norm as they think that long term investing is a poor investment choice.
5. Almost all of their investment decisions are based on fear or greed. A hot tip at a party is viewed with greater respect than that of a financial adviser. Their portfolio is moved from broker to broker or between different investment managers. Their poor luck is always the fault of someone else. Toward the end, they are selling their house or houses, and moving down to less expensive areas.
The Goal: Every retiree should strive conducting their affairs like the "good" retiree detailed above.
1. A solid plan, if possible, of income streams should come from different sources, such as pensions, annuities, bonds, stock dividends, and social security.
2. A budget that restrains spending in which basic living expenses can be largely covered by guaranteed income sources such as pensions, high quality income sources, and social security.
3. Funds are set aside for unexpected expenses.
4. Investments are made to cover the ravages of future inflation, such as covered in this article. Dividend growth stocks are an excellent way to guard and protect one against inflation.
5. An estate plan is needed for a variety of reasons unique to each family.
6. A core investment portfolio of solid securities. All investors need core stocks for the backbone of their portfolio. The following are excellent stocks (with current yield) that are excellent selections for one's retirement portfolio. Adding to this core with high yielding telephone, MLPs, REITs, or more electric utilities stocks will provide for additional income.
- Procter & Gamble (PG), 3.3%
- Conoco Phillips (COP), 3.8%
- McDonald's (MCD), 3%
- Colgate (CL), 2.6%
- Southern Company (SO), 4.4%
- Intel (INTC), 3.5%
- Wal-Mart (WMT), 2.6%
- Abbott Labs (ABT), 3.6%
- Johnson & Johnson (JNJ), 3.6%
- Chevron (CVX) 3.3%
- Pepsico (PEP), 3.2%
The final word is to be like the "good" retiree so that the golden years will be filled with years of enjoyment and security and not years of worry about finances. Senior years have enough challenges without adding poor financial planning to the mix.
Disclosure: I am long MCD, COP, SO, INTC, JNJ, PEP, ABT, PG, WMT, T.