Why Your Grandparents' Playbook Won't Score
Increasing life expectancies means today's retirees can expect to spend more time in retirement than any generation prior. Good news, to be sure. But is your investment portfolio prepared to live as long?
"Most investors have the longevity to ride out market cycles," says Larry Fink, Chairman and CEO of BlackRock, "and they should use that to their advantage." For some, that may require rewriting their retirement rulebook, particularly in the current low-yield environment.
Many Americans can expect to spend more than 20 years on the beach,so to speak. This tells us that retirees in the US need to look beyond the traditional "retirement assets" of bonds and cash. Today's retirees should consider equities, commodities and alternatives to help generate income from their portfolio and deliver returns in the long run.
The danger of a too-conservative approach is the very realprospect of running out of assets for tomorrow. This wisdom applies to investors of allages. "You have to ask yourself, can I afford the cost of earning zero today, and what does that mean over the course of 30 years?," says Mr. Fink. "The biggest risk for investors today is not whether the market is going up or down in the next week or the next month. It's in not making decisions for theirfuture."
Avoid Dollar Cost "Ravaging"
One of the most important decisions retirees need to make is how to draw down their nest egg to generate the income they require. Simply selling investment shares at regular intervals as a source of cash flow can backfire. Chris Leavy, Chief Investment Officer of US FundamentalEquity, explains "When accumulating assets, investors use dollar cost averaging. By purchasing a fixed dollar amount of an investment at regular intervals, they buy more units when prices are low and fewer units when prices are high."
For retirees,or decumulators, the concept works in reverse. "If you're taking out a fixed dollar amount on a monthly basis, you're selling fewer units when prices are high and more units when prices are low," he says. "Dollar cost averaging becomes dollar cost 'ravaging' because you're actually doing the exact wrong thing at the wrong time."
Mr. Leavy recommends funding a higher proportion of withdrawals from aninvestment's income component (bond coupons or stock dividends) rather than from the sale of principal. "An investment's net asset value fluctuates day to day, so selling too many shares at the wrong time can devastate a nest egg. Income streams, even equity income streams, are not nearly as volatile as prices."
Of course, this is merely a starting point. An experienced financial professional can help you to construct a portfolio that is retirement ready. Mr. Fink sums it up well: "Long life is a blessing. Don't let a lack of action and preparation make it a financial burden."
- Seek income through stocks that pay and increase dividends.
- Look to corporate bonds and emerging market debt for higher yields.
- Hedge inflation through inflationprotected bonds such as TIPS.
- Consider commodities for their inflation hedge and emerging markets exposure.
- Add alternative investments to potentially reduce
Investment involves risks. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed income investing are interest-rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Investments in non-investment-grade debt securities (high yield or "junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.
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