Managing your investment portfolio during your working years is relatively easy—you can stash your 401(k) money in target-date funds, all-in-one portfolios designed to simplify retirement saving by automatically adjusting your asset mix over long periods of time.
“But when you retire and start living off your savings,” says top retirement advisor Nicholas Bunio, CFP, “portfolio management takes on a new urgency and requires more attention. It can be a tricky balancing act of protecting your nest egg and making it last for the rest of your life.”
Bottom Line Personal asked Bunio to explain portfolio management for seniors and offer strategies to build and manage your portfolio….
What Is Portfolio Management?
Seniors actually have two types of portfolios to manage, both of which are critical for a satisfying retirement…
Financial portfolio. Along with guaranteed income such as Social Security and pension benefits, a financial portfolio provides you with monetary support and stability in retirement. Managing that retirement investment portfolio involves selecting, overseeing and adjusting a collection of financial assets to meet specific goals and taking measured risks that allow you to sleep at night.
“Project” or activity portfolio. This type of portfolio covers your daily activities—how you spend your time and energy…and how you prioritize health, family, friendships, creative pursuits and volunteer work. Most retirees don’t have to factor out “fun” into a separate portfolio, but many forget about how much “fun” will cost. Having additional cash, interest-bearing accounts such as bonds and annuities, or simply being mindful of how to afford fun is a must in retirement.
Core Principles of Portfolio Management
There are several principles to consider when managing any portfolio…
Diversification: Spreading your investments across many different types of assets that don’t move in unison. Not just different asset classes—stocks, bonds, cash—but also sectors (technology, energy)…geographies (US, international and emerging countries)…company sizes (large-cap, small-cap)…and even different investment styles (fast-growing aggressive investments and undervalued conservative ones). “Diversification protects against catastrophic loss,” says Bunio, “ensuring that one bad investment doesn’t wipe out a lifetime of savings.”
Asset allocation: Strategic decisions you make to divide your portfolio among different asset categories, primarily stocks, bonds and cash. Asset allocation allows you to balance growth and safety. As a retiree, you may need your money to last 20 to 30 years, which means you still need the growth that stocks offer but also the stability of bonds and cash to fund near-term living expenses without having to sell stocks during a downturn.
Risk management: The ongoing process of identifying, measuring and controlling threats that could derail your retirement. You have to be prepared for risks beyond just declines in the stock market, including…
Inflation risk—the rising cost of living eroding your purchasing power over time.
Longevity risk—running out of money in very old age.
Sequence-of-returns risk—bad returns early in retirement can greatly reduce how long your portfolio will last.
Portfolio-Management Strategies for Seniors
Most retirees aren’t looking to spend hours researching investments but want to enjoy their time in retirement. Following these three strategies can help balance investment risk with living life in retirement…
Strategy #1: Match your portfolio returns to your retirement goals. Many retirees measure the success of their portfolio’s performance by whether it beats the return of the broad stock market—but beating the stock market is arbitrary. “What really matters,” says Bunio, “is how much return you need to achieve your goals. Then you can manage your portfolio to take the least amount of risk to achieve that return.”
Strategy #2: Use mutual and/or exchange-traded funds for your portfolio. Most retirees don’t have the time, skill or desire to oversee dozens of individual stocks or hundreds of bond holdings. Better: Consider using mutual funds or exchange-traded funds (ETFs). Two categories to consider…
Active funds, in which a fund manager tries to beat a benchmark index by picking investments. Active funds have the potential to outperform in volatile or niche markets, but they come with high fees.
Passively managed funds and ETFs automatically track a market index (such as the S&P 500) and often offer rock-bottom fees.
Strategy #3: Adjust your portfolio as you age. “Retirement isn’t a single life phase,” says Bunio. “It’s helpful to divide retirement into three broad periods…”
Go-Go Years (ages 65 to 75). Many retirees are healthy, active and spending on travel and hobbies during this period. Portfolio priorities: Maintain meaningful stock exposure (50% to 60% in equities), so you can keep up with long-term inflation and make sure you can draw down from your nest egg for another 30 years.
Slow-Go Years (ages 75 to 85). Lifestyle spending plateaus and even dips. Health-care costs may rise. Portfolio priorities: Reduce stock exposure as preservation becomes more important than growth (30% to 50% in equities).
No-Go Years (ages 85 to 95). Preserving independence and simplifying finances are paramount. Portfolio priorities: Keep some stock exposure—“even at 90, inflation can remain a risk,” says Bunio. Also maintain significant liquidity. Make sure you have money available for assisted living and unexpected medical costs.
Steps to Building and Managing Your Portfolio
1) Set your objectives. “In retirement, you need to think about balancing five strategic objectives simultaneously as you construct your portfolio,” says Bunio. They include…
Income: How much income your portfolio needs to generate? Subtract your annual guaranteed income (e.g., Social Security) from your annual living expenses.That gap is what your portfolio must reliably fill each year.
Growth: How much does your portfolio need to grow to stay ahead of inflation? Even 3% annual inflation can cut your purchasing power in halfover 25 years. Stocks are the only asset class likely to beat inflation over long periods.
Longevity: Can your portfolio sustain you the rest of your life? Multiple studies have shown you can withdraw about 4% annually from a portfolio of 50% stocks and 50% bonds with a very high probability of not running out of money over the next 30 years. “If your withdrawal rate is higher,” says Bunio. “You may need to revise your retirement goals.” But if your goal is to bounce your last check, 4% might be too conservative.
Liquidity: How much accessible cash do you need? You want to keep at least one to two years of expenses in cash or cash equivalents such as short-term US Treasury bonds.
Legacy: Do you plan to spend down most of your money during your lifetime or leave a significant inheritance for your heirs? A strong legacy objective can mean maintaining more stock exposure later in life
2) Choose the right mix of assets. “Asset allocation determines the vast majority of long-term portfolio performance,” says Bunio. Over the past century, US stocks have returned 10% annually with high volatility…bonds, 4.5% to 5.5% with moderate volatility…cash, 3.3% with almost no volatility.
3) Monitor and adjust your portfolio. An annual portfolio review can do more for your retirement success than constantly watching the market. “You don’t have to make frequent changes,” says Bunio, “but be prepared to make careful changes at least once a year.” Take the follow steps during your review…
Compare your current portfolio allocation to your desired long-term allocation. Example: Your desired portfolio may have started out holding 70% stocks and 30% bonds, but in a strong bull market, your allocations may have risen to 80% stocks and 20% bonds. Rebalance your mix, trimming your current stock exposure and raising your bond exposure.
Look for tax opportunities. If your taxable investments have losses consider “tax-loss harvesting,” selling investments at a loss to offset capital-gains tax liabilities incurred from selling other profitable investments.
Review your retirement timeline. Ask yourself, has my spending changed?…has my health changed?…have my legacy goals changed?…do I need more income stability?…do I still have the right balance between growth and safety?
Common Mistakes to Avoid
These three mistakes are among the most damaging that a self-directed retiree can make…
Mistake: Overconcentration. Many retirees have too much money invested in a single stock, sector, fund or asset class. Examples: You own a large position in a former employer’s stock…or you own several funds whose top holdings are the same giant tech stocks. “Very concentrated positions can severely damage a portfolio if those investments go through a rocky patch,” wants Bunio.
Mistake: Ignoring risk tolerance. In bull markets like the current one, it’s easy to be an aggressive stock investor, but you may be taking on more risk than you can handle. “Stress-test your portfolio,” advises Bunio. The average bear market has stock losses of about 35% and lasts 14 months. Moreover, it takes the market about two-and-a-half years to rebound from a bear market bottom and reach new all-time highs. “Ask yourself if you have both the financial and emotional capacity over that period to stay invested, maintain your lifestyle and let your portfolio recover,” says Bunio.
Mistake: Failing to review your portfolio regularly. Pick one date per year to do this, and stick to it. “Many retirees do a review in early January when their year-end statements arrive or mid-October when there’s still time to make tax moves before year-end,” says Bunio.
When to Seek Professional Help
Key signs that it may be time to bring in an investment advisor…
You’re making poor decisions.Market declines cause you to panic and make mistakes.
Your portfolio has become too complexwith multiple accounts and a long list of funds and ETFs that no longer seem to fit together
You’re unsure about withdrawal strategiesand what accounts to tap to maximize tax efficiency.
Your financial situation has grown more complexdue to family changes or health issues.
What to consider when you hire an investment advisor….
Decide how much help you actually need. “Many retirees think they have to turn their investment portfolio over to an advisor,” says Bunio. “In reality, there’s a middle ground.”
If you are looking for limited help or advice: A fee-only advisor charges a flat fee (e.g., $3,000 to $10,000/year) or an hourly rate ($100 and up).
If you want someone who can actually manage your investments: Consider an SEC- registered investment adviser who charges a percentage of the assets managed (typically 0.5% to 1%).
Make sure your adviser is a fiduciary, meaning that he/she is legally required to act in your best interest at all times.
Understand the advisor’s investment philosophy. Ask him/her the following questions…
How do you build portfolios?
Why do you use certain funds or ETFs?
How will you generate retirement income for me?
How do you manage risk and market downturns?
Bottom Line Personal interviewed Nicholas Bunio, CFP, retirement-planning specialist with Retirement Wealth Advisors, a fee-only investment-management and financial-planning firm, Berwyn, Pennsylvania. He specializes in retirement planning for doctors, teachers, nurses and federal employees.
