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If you want to retire with confidence, have a plan.
Larry Stein, CFP®, author of Peace of Mind Investing, says, “As you near retirement age or even within a decade or so, it is time to start doing some serious financial planning. Retiring with confidence is to develop a plan that makes sense, executing it, and reviewing it at least every five years to make sure you’re on track.” Good advice.
When it comes to retirement planning, we need to consider a number of risks—factors we know are likely to happen and factors that could potentially affect us. This includes increased longevity, inflation, family responsibilities (such as caring for parents), healthcare, and interest rates. All could have a major effect on finances and lifestyles.
Let’s take a look at one possible scenario. Stein says a couple with both spouses at age 65 today has a 50 percent chance one of them will live past 92 and a 25 percent chance one will live to 97, a lifespan during which challenges can arise. In other words, we are living longer, and this means we need to plan with more potential risks in mind. So unless you have serious health concerns or unfortunate heredity, basing your financial planning on a 95-year lifespan makes sense.
Prudent investing is built on a single premise that’s been time-tested through the Great Depression, two world wars, and multiple other major events – yet it is incredibly simple. The grand premise: stock prices rise over time. So planning for retirement with this in mind means smart investing can put you at an advantage.
Setting Goals
Everyone’s circumstances are different, but we can all expect the stock market to follow certain patterns based on its history—never guaranteed, of course—but have clues to what we can expect to see over time. As you invest in the market, you need to set return goals that make sense for your specific personal situation, not goals based on generic advice.
The only benchmark that makes sense is to set out to achieve your personal goals over a time horizon that fits your specific situation. How much do you have saved now? What will it cost to maintain your lifestyle in retirement? How soon will you be retiring? Only you can answer the questions that will form the foundation for the goals you want to achieve.
Your performance goals ideally should be the rate of return you need to live comfortably through retirement. The true measure of investment performance is your return through a full market cycle, up and down.
Stein says, “Beating the S&P 500 or any other such nonsense is pure noise and distraction.” This is sound advice and something to keep in mind as you set your retirement goals.
Managing Risk
Managing risk through asset allocation and rebalancing is key to effective retirement planning.
Simply stated, you don’t want to put all of your eggs in one basket. Your nest egg should include an array of investments—different types of investment assets, different industries, different geographies, and an overall mix of funds—in your portfolio.
The idea is to spread your investments around, limiting your exposure to any one particular type of asset. If stocks go down, you’re balanced by holding bonds as well. If the transportation industry is affected, you may also hold assets in a sector that’s doing well, such as energy. If U.S. manufacturing stocks go down, you would be less exposed if you are also invested in global manufacturing. Diversification is designed to help reduce your portfolio’s volatility over time.
Rebalancing is another important aspect of reducing your risk in retirement planning. Rebalancing is the process of realigning how things are weighted in your investment portfolio of assets. Ideally, you would rebalance your portfolio by periodically buying and selling assets for the purpose of maintaining a certain level of asset allocation or risk.
For example, early on in your retirement planning, your target asset allocation might be 70 percent stocks and 30 percent bonds. A decade later, you might want to reduce your stock allocation to 60 percent and increase your bond allocation to 40 percent. And as you near retirement, you’d increase your lower-risk investment allocation even more.
What you’re looking to do is minimize risk. Your appropriate asset class mix will depend on various factors, including your investment horizon, which largely depends on your age when it comes to retirement planning.
Reducing Risk During Euphoria and Overvaluation
Reducing risk is essential to any effective retirement plan. If you want to play the market and take big risks when you have decades to make up for your losses, that’s one thing. But when your wage-earning years grow numbered or if your resources are limited, keep a close watch on risk. You don’t want to build a comfortable nest egg only to watch it waste away by not following a strategic plan.
This is why it’s so important to trim risk during euphoria. If you aren’t familiar with this term as it relates to investing, euphoria is the point in a bull market where it seems as if everything is going way up. Stocks and other types of assets are on the rise, and what tends to happen is people jump in, irrationally, due to a fear of missing out. But this can get risky, depending on your time horizon, as the market will normalize.
To avoid risk as you head into retirement, you should generally avoid investing during overvaluation. An overvalued stock has a price not justified by its earnings outlook and is trading at a rate that’s significantly and unjustifiably in excess of its peers. This often happens when there’s an uptick in emotional trading for some reason that artificially inflates the stock’s price. There are times in which investors tap into overvalued stock strategically, but it’s risky; to retire with confidence, you’re looking to minimize risk.
So instead of investing during euphoria or overvaluation, it’s generally best to buy during times of fear and undervaluation when prices are low. For retirement, you are looking at the long-term early on rather than quick gains, and as time goes on, volatility, even on the uptick, is risky.
Bottom Line
If you want to retire with confidence, have a plan. Taking calculated risks early on but avoiding excessive risk over time, diversifying and rebalancing your portfolio according to your time horizon, and employing strategies with guidance from a financial advisor can help you stay on track to reach your retirement goals, confidently.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.