The near-retiree, defined as having a retirement date of two years or less, is in a unique situation. It is an opportunity for reflection on important things like:
- What will give the rest of my life meaning?
- What will I do with the gift of time that retirement brings?
- Will I have enough money to live the way I want to?
I sincerely hope all near-retirees will dedicate the time to contemplate these interdependent ideas. The focus of this article is the third question, put succinctly by Ameriprise through the distinguished Tommy Lee Jones as, "Will you have enough money to live on your terms?" This question can evoke genuine anxiety and fear -- a reaction that Ameriprise and Tommy Lee are counting on. The uncertainty about having the resources we need can affect anyone regardless of circumstances. Fortunately, the near-retiree is in a position to address the issue confidently in a way that removes the fear and anxiety.
The plan outlined here is designed to:
- assure a basic level of income
- prevent significant loss of income
- participate in market gains
- benefit from market declines
The strategy divides all financial assets into two buckets: investments with guaranteed or near-guaranteed income and cash.
As many responsible advisors recommend, the first step is to identify your level of basic expenses not covered by Social Security and reserve enough assets in vehicles that will guarantee this amount of income. It's not necessary to limit yourself to the bare basics like food, shelter, and warmth; quality of life expenses such as hobbies, travel or education are also included. This is certainly not a new concept; the key is doing it correctly.
There are only a small number of investments suitable for this category: investment grade short or intermediate term bonds, annuities, pensions, and stocks with unbroken, multi-decade records of paying increasing dividends. See the Appendix below for a full discussion of these investment vehicles.
All remaining assets go to cash or cash-like vehicles such as CDs. This is money that must be there in the future. The consequences of having a major loss before retirement are far greater than missing out on any gains before then. If the market goes higher in the next couple of years, you will still benefit from market gains with the equities portion of the money set aside for basic expenses income. The value that might be lost to inflation is minimal given the short timeframe.
As retirement approaches, cash is converted into income-producing investments. The near-retiree is in a unique position to benefit from a high level of cash. If the market is lower at retirement then you will be in the enviable position of being able to get more for your money in terms of income. If the general market is higher there are always opportunities in specific sectors. You don't have to predict where the good values will be -- they are always there. The energy sector today is a good example. Exxon Mobil (NYSE:XOM), has recently been at the same price as two years ago, and others such as Chevron (NYSE:CVX) have been significantly lower. Outside of energy Caterpillar (NYSE:CAT), International Business Machines (NYSE:IBM), and other companies provide similar opportunities.
The prospect of missing out on market gains plays a different role at this time of life. There's nothing wrong with hoping for future gains, but at this point in life it would be irresponsible not to plan for the possibility of stocks at much lower levels one or two years from now. To many investors the signs are becoming stronger almost daily. You do not want to find yourself at retirement regretting that you ignored warnings from the Shiller Cape Ratio, margin debt levels, commodity prices, deteriorating global growth, and market internals to name just a few.
The bottom line is that the consequences of having a big loss before retirement are far greater than missing out on any gains. The money needs to be there at retirement, and you don't have the latitude for making up losses as you did earlier in life.
Implementing a plan in the last couple of years before retirement is crucial. We are bombarded by advertisements that play on real fear and anxiety based on looming uncertainties regarding our financial future. Waiting until the big day is too late. A plan developed earlier, even if it was retirement-focused, will require changes to respond to the ever-changing economic landscape. Even if we engage Ameriprise, Fidelity or one of the myriad other companies, specific decisions about allocating assets are still up to the individual. Seeking Alpha readers wouldn't have it any other way. The plan outlined here is one that will insure a basic level of income, prevent significant loss of income, participate in market gains, and allow the investor to take advantage of market declines.
Appendix: Investing for a basic level of income
The vehicles suitable for this are investment grade short or intermediate term bonds, annuities, pensions, and stocks with unbroken, multi-decade records of paying increasing dividends.
Government bonds generate low income but the highest safety of income and capital. Corporate bonds, providing better but still low income, are higher in the capital structure than equities. Bonds of stalwarts like Proctor & Gamble (NYSE:PG), Coca-Cola (NYSE:KO) and Exxon Mobil are as safe as Treasuries in this timeframe. Bond ladders, as described by Jesse Felder on Seeking Alpha, are a highly effective approach to bond investing. Bonds should be acquired at or below par to avoid a loss of capital on maturity. Bond funds are not suitable because of possible loss of capital and income.
Those fortunate enough to have a pension can count this as near-guaranteed income, although as government retirees in Rhode Island, Detroit, and some California cities have learned, nothing is certain. In addition, time will tell if the shamefully underfunded Pension Benefit Guarantee Corporation will get the same quasi-governmental backing as Fannie Mae and Freddie Mac did in 2009.
The only acceptable stocks are those with unbroken, multi-decade records of increasing dividends, such as the lists at dividend.com and dripinvesting.org. Even these must be selected carefully, as companies like Pitney-Bowes (NYSE:PBI), Pfizer (NYSE:PFE) and General Electric (NYSE:GE) have been removed over the years. Mutual funds, other stocks, REITs, and MLPs will not provide both the income and capital safety levels needed.
Diversification is as important here as in any other scenario. While the reliable dividend paying stocks are currently the highest-paying category, each class has unique strengths.
Disclosure: The author is long KO, XOM.
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.