Retirement Planning When You Have Enough
Not every retiree needs to gun for higher returns, but a conservative portfolio can court its own risks.
A version of this article previously appeared in September 2020.
At age 70 and divorced, Ted was savoring life in a warm climate, spending time with his significant other, enjoying his photography (and making a little bit of money on it, too), and relishing his close bond with his adult daughter. He was extremely frugal--purchasing a small SUV that he expected to keep for many years was a rare splurge. Ted told me that he was content to make do on Social Security and extremely modest portfolio withdrawals of less than 2%. And his portfolio wasn’t huge--about $450,000 in 2018. That translated into a $9,000 annual cash flow from his portfolio, and even less when taxes are taken into account.
Because Ted’s portfolio was so conservatively positioned, with about 70% of assets in cash and bonds, I had some concerns about the effect of inflation on his purchasing power, especially because he noted that his healthcare expenses were beginning to flare up. Thus, my “After” portfolio nudged up his equity weighting to 50% of assets from 30% previously. With a spending rate as low as Ted’s, I argued, he absolutely could afford to take more equity risk; even if his equity holdings encountered a sustained bear market, there was little to no chance he’d need to sell them in a trough. And switching into a more-aggressive portfolio mix would probably enlarge his eventual balance, which he could use for travel or pass on to his daughter.
But in hindsight, I wondered if my increase of stocks in the "After" portfolio was more reflexive than it was necessary. Yes, his bond-heavy starting portfolio had low return potential, and yes, a heavier equity allocation would likely bump up returns, albeit with extra volatility. But given Ted’s very modest spending rate, he could afford to maintain a more conservative asset mix that provided him with more peace of mind than he’d be able to have with a more stock-heavy portfolio. His portfolio was enough.
“If You’ve Won the Game...”
Ted’s approach reminds me of the saying I most closely associate with asset-allocation guru Bill Bernstein: “If you’ve won the game, quit playing.” The basic idea is that if you’ve built your portfolio up to a point that it meets your goals--as did Ted--you don’t need to keep gunning for additional returns. Instead, you can switch your focus to extracting your cash flows from a more conservatively positioned portfolio that provides you with peace of mind.
Ted’s case is also an illustration that you don’t need to have several million dollars to shift into the “enough/peace of mind” camp. People of more-modest means can get there, too. The key is that the portfolio spending rate must be low enough to make it work, and the portfolio should be positioned to support that spending as well as to accommodate inflation and short-term spending shocks.
At the same time, maintaining a very conservative portfolio can introduce risks of its own: Namely, that the portfolio may not grow enough to support the planned spending rate, or that spending could increase due to inflation or a lifestyle shock, such as long-term care expenses later in life. If you’re inclined to de-risk your portfolio for retirement because your spending rate seems low relative to your portfolio size, be sure to consider the following as part of your calculus.
“Safe” Assets’ Low Return Potential Poses Challenges
A key consideration for investors attracted to a less-volatile portfolio that features lower equity exposure is that the return potential of fixed-income assets has dropped markedly over the past several decades. Current yields are a good predictor of what bonds will return over the next decade, and the 10-year Treasury yield is 1.4%. Other high-quality bonds yield a bit more, but it’s hard to push yield much over 2% without taking substantially more risk.
That has implications for safe withdrawal rates. After all, the 4% guideline has only been stress-tested over periods featuring much higher yields, and the back-tests featured a balanced equity-bond portfolio, not one that skews heavily toward bonds. That suggests that retirees who wish to maintain very conservative portfolios also need to be similarly conservative about their withdrawal rates. Ted’s 2% withdrawal rate doesn’t seem too far off the mark. The trouble is, many retirees won’t find that to be a livable income stream.
Spending Could Change
And even as you might have a disciplined spending plan in mind for your retirement, it’s also worth bearing in mind that in-retirement spending isn’t 100% within your control. Anyone who has gone to the grocery store or filled up their gas tank this summer is aware of the risk of higher prices. Whether the current inflationary trends will prove fleeting or more lasting is the subject of active debate, but inflation is certainly a risk factor for retirees who aim to hold their spending at very modest levels. It’s also important to consider that your own inflation experience could be different from CPI at large, especially if healthcare-related costs consume a large share of your spending. Higher inflation has the potential to drive your overall spending--and in turn your withdrawal rate--higher than you intended, even if consumption remains the same.
In addition to inflation, it’s worth considering that what you spend money on--and in turn your total spending rate--might change over your retirement life cycle, too. Research from retirement researcher David Blanchett at QMA points to spending tapering down in the middle years of retirement, then flaring up toward the end, largely due to uninsured healthcare costs. If you haven’t made a plan for long-term care expenses should they arise, it’s particularly important to factor in those potential costs.
The Value of a Second Opinion
There are so many moving parts in creating a retirement plan; changes in one part of the plan have repercussions in another. For that reason, it's valuable to get a professional opinion on any asset allocation or withdrawal setup you're contemplating, to understand and troubleshoot any unintended consequences.
It's also worthwhile to consider all of your spending sources together--not just your portfolio, but also any income you'll derive from Social Security, pensions, or any other sources. After all, if your aim is to create a conservative plan, one of the best ways to ensure that is to create a baseline of retirement cash flows through non-portfolio sources to cover very basic living expenses. That takes pressure off the portfolio and portfolio withdrawals, which in turn can contribute to peace of mind.