Three More Questions Retirees Ask - Rodgers & Associates
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Three More Questions Retirees Ask

Key for Retirement

This summer I started a series on planning for retirement. Many people find retirement planning scary and intim­i­dating. Hopefully you only retire once and you want to get it right the first time. This series answers some of the most common questions we hear.

See the other posts in the series here:

What kind of invest­ments do you recommend for retirees?

Invest­ments should be coordi­nated with a retiree’s individual need for income, growth of income, safety of principal, and liquidity. In short, a financial plan needs to be created first. An investment strategy can then be developed to incor­porate all the retiree’s goals together. Retiree’s often mistakenly believe they need to invest in income producing invest­ments. This often leads them to develop a portfolio which produces little or no growth leaving them vulnerable to inflation. The other problem with a fixed income focus is the temptation to sacrifice quality in an attempt to increase yield. Higher yield = higher risk. The proper investment strategy focuses on total return – growth plus dividends and interest. Total return provides the best chance of producing an income stream which increases year after year to fight inflation. A total return strategy is also more tax efficient as some income will be derived from capital gains. Capital gains have a lower tax rate currently than fixed income.

I’ve heard some people say retirees should not invest in stocks. Are stocks really good retirement invest­ments?

There is a myth going around which says your allocation to stocks should decrease as you get older. I’ve even heard it stated as a formula. Subtract your age from 100 to get the correct allocation to stocks. Using this formula, a 65-year old should only have 35% invested in stocks. This may have worked OK for retirees 50 years ago when they were only expected to live 5–10 years after they retired. However, it doesn’t work for today’s 65-year old couple facing 25–30 years of inflation during retirement.

Most people realize stocks have produced better returns than fixed income over time. The problem with owning stocks is their volatility. Many investors sell their stocks in down markets fearing the market will go even lower. They leave their money on the sidelines while stock prices recover only to buy in again near the top of the cycle. This vicious cycle starts over again when stock prices drop in the next downturn.

Retirees may be better served to embrace the volatility of the stock market. If stock prices were stable, the returns may not be as high. The investing profession calls this a “risk premium.” This simply means that if an investor is to put up with the volatility of his or her portfolio, that investor should be rewarded with a higher return (although there are no guarantees). It makes sense.

Retirees tend to focus almost entirely on the total market value that appears on their monthly state­ments. Instead, they should focus on the sustained income potential of the portfolio over time. Retired investors are never going to liquidate the entire portfolio on any given day. Those invest­ments are there to provide income. That income needs to increase each year to keep pace with inflation. This is why retirees need stocks in their portfolio. You cannot retire with a 100-percent fixed portfolio and fight inflation.

By embracing volatility, you recognize stocks are going to be consis­tently mispriced. They will be overvalued during times of euphoria and under­valued when fear grips the public. We believe a successful investor will recognize this truth about the market. He or she will also recognize that no one will ever be able to predict when this is going to happen.

I’ve always liked real estate as an investment. Should I own real estate?

The miscon­ception for a lot of people is that real estate is an investment. Real estate does not grow in value on its own. In fact, you have to contin­u­ously put money into it just to maintain its value. We believe the price appre­ci­ation experi­enced with real estate is really only the result of inflation.

Many investors choose to partic­ipate in real estate invest­ments called Real Estate Investment Trusts (REITs). REITs offer exposure to real estate invest­ments for growth and income. There are mutual funds which focus on real estate including REITs which offer more liquidity than owning real estate outright. Owning real estate through a fund can be can be an important part of a diver­sified portfolio.

See the other posts in the series here:

Rick’s Tips:

  • Focusing on fixed income invest­ments to generate retirement income ignores the need for growth to fight inflation.
  • Retirees should focus on the sustained income potential of their portfolio over time and not allow volatility to scare them out of their stock positions.
  • Real estate can be part of a diver­sified portfolio through the use of real estate mutual funds.