Planning for Your Retirement the Smart Way

by Neal Frankle, CFP ®

This post was originally published in December 2009 – about the same time most main stream publications were advocating staying out of stocks for good. 

Planning for your retirement is serious business. That’s why I get so angry when misinformation gets floated around. I recently read on a blog that if you retire now or want to do so shortly, you should buy CDs, bonds or preferred stocks, or take an annuity payout in order to create that income.

I don’t have a big problem with these investments. But they sure aren’t the smartest or only way to create retirement income if you are planning on living for 10 years or longer after you retire. (More on that in a bit.)

Indeed, one of the best investments for income during your retirement is equities.

Should you put all your money in equities all the time? I don’t think so. But you shouldn’t ignore these investments or shy away from them just because you’ve reached a certain age.

This might sound crazy but your age has almost nothing to do with how you should invest.  Your investment time horizon is much more important.  That’s what you need to think about before you make an investment decision. Often, that has little to do with reaching life’s milestones – like retiring.

When you retire, you should be most concerned about how long and how much you can withdraw from your nest egg…right?  Say you retire at age 65. How long are you going to live?  Statistically, you’ve got a good 25 years to go. That means your investments have got to keep working another 25 years…right? Simple.

But if you shift most of your money into bonds right when you retire, you may not make enough money to last the rest of your life.  Of course, if you did shift all your money into fixed income investments, you wouldn’t be alone. But that doesn’t mean it’s the best way to go.

Take a look at the chart below.

It shows how long you could make inflation-adjusted withdrawals from your account before running out of money.

I’ve highlighted two examples. The first shows that had you invested 75% of your money in equities and 25% in bonds and withdrawn (inflation adjusted) 5% for 30 years, you would have succeeded 98% of the time. Meaning had you done this you would have run out of money before you ran out of life only 2% of the time. ( Of course the past is no guarantee of future results.)

On the other hand, had you invested all your money in bonds, you’d be able to stay retired only 20% of the time. The other 80% of the time, you’d go back to work or move in with the kids.

Do stocks always beat bonds? They certainly do not.  Sometimes, as you already know, stocks can do really nasty things for a very long time. In fact, 2000 through 2010 was a particularly difficult decade with stocks showing no return.

I am simply saying that to ignore an asset class that is probably the most important asset tool at your disposal to create retirement income is a huge oversight and mistake.

What say you? Should people who retire put more money into bonds and fixed income? Did you do that when you retired? Or are you planning on doing so?

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{ 16 comments… read them below or add one }

Doctor Stock December 27, 2009 at 12:14 PM

It’s not so much where our money is… it is how we invest it, particularly when we sell. Too often, retirement and stocks means investors buy and hold… and then… crash. It’s more important to know when to get out, than to buy a bunch of bonds because people won’t think.

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neal@wealthpilgrim December 27, 2009 at 12:30 PM

Doc,

I personally agree that the system investors use is critical. Allocation is the most influential factor on returns but after that, it’s the system you use.

The problem is that all systems fail at times. Investors often abandon their system when it underperforms because they have unrealistic expectations.

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Neal Frankle December 24, 2009 at 12:53 PM

Sam,

At birth, you are right, you have a life expectancy of 78. But if you are 65, according to SSA gov stats, female has about 20 years to go. Male has a bit under 17.

http://www.ssa.gov/OACT/STATS/table4c6.html

Also, what do you base your dislike of having equities as a component of a 20-year – or in your case – 13 year investment horizon?

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Financial Samurai December 24, 2009 at 1:30 PM

Those stats are lies, all lies! We can’t count on living past 78 years old, and we can’t on transforming into women when we’re 65! :p

Equities weren’t fun in 1997, 2001-2003, and 2008-2009. I’d rather just earn 4-6% in fixed income, than try and put my entire NUT in the equities market.

It’s about building the NUT first, and nut rely on equities to build the NUT. Once you have $500,000 in the bank for example, a 5% return starts making a diff (25K) with zero risk.

But, to try and get a 25% return investing your 100K in the stock market…. not worth it.

I’m risk adverse with my portfolio… but I do love to punt with 50K every year and hope for a 10 bagger!

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Financial Samurai December 24, 2009 at 12:21 PM

Sorry Neal, but statistically, we actually only have 13 years left to live if we retire at age 65, that’s why I’m hell bent on retiring before the age of 45, NO MATTER WHAT! ;)

Equities aren’t a cornerstone for retirees at all. Instead, they are a risky desperate attempt to try and make more money.

No matter how much money I accumulate, I will probably never ACTIVELY invest more than $50-100,000 in the markets. Yes, I can leverage it up to $150-300,000 and make punts, but the most I will lose is 50-100K, and that’s that. No way am I going to dump everything else in the markets. Not worth it to me and it shouldn’t be for retirees either!

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neal@wealthpilgrim December 23, 2009 at 4:39 PM

How does that work Tim? What’s held within the MLP? If that’s the case, they must include growth stocks and high-yield bonds….

Doesn’t it depend on the securities w/in the MLP?

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Tim Wright December 23, 2009 at 3:46 PM

I use them as income like bonds but with growth potential and inflation protection. The return on bonds is much lower than an MLP.

Tim

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Tim Wright December 23, 2009 at 11:00 AM

Hi,

I don’t use bonds I use MLP’s like KMP, OKS, instead of Bonds. One of my MLP’s this year only lost about 6% and yet was yielding 9% in dividends. Whats you thought on this Neal?

Tim

Love your blog, thanks so much.

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admin December 23, 2009 at 12:19 PM

Well…the MLP would act like a bond if it holds bonds. It simply gives you more diversification.

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Jackie December 23, 2009 at 8:15 AM

I think a good mix of stocks are an important part of an after-retirement portfolio, but that it should also be re-evaluated regularly. Emotions come into play too. It can be hard to be 80 and watch your portfolio drop by 40%, even though you probably still do have a 10 year investment horizon.

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Neal@WealthPilgrim December 23, 2009 at 8:58 AM

You hit the nail on the head. The emotions play a huge role. It might make sense for an individual NOT to have equities.

But to talk about retirement income and ignore the entire asset class?

I’m just saying…hey MF (Motley Fool), let’s be a bit more intellectually honest.

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Evan December 23, 2009 at 7:41 AM

The difference, Neal, is that you prepare your calcs, pursuant to your client’s individual needs. The fool needs to provide an article that will appeal to the masses.

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Neal@WealthPilgrim December 23, 2009 at 8:54 AM

OK….good point. I see that.

Just the same, when you or I write, don’t we have a responsibility to be a bit more complete.

Sure, the article they wrote will appeal to more folks…..but it may also damage them.

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Rob Bennett December 23, 2009 at 7:22 AM

I agree that it’s foolish to take your money out of stocks when you retire. You may be retired for three decades. You’re going to accept returns of about half what you could get in equities for that entire time-period? That makes little sense to me.

The reason why this advice has become somewhat popular is the perceived riskiness of stocks. I believe that the riskiness of stocks has been greatly overstated because of the dominance of the Buy-and-Hold model in recent decades. Almost all of the risk of stock investing comes from going with a high stock allocation at times of insanely dangerous prices (stocks have never performed poorly in the long term starting from a time of reasonable prices but have always performed poorly in the long term starting from a time of high prices). The obvious answer (in my view!): Discard Buy-and-Hold! Pay Attention to Price!

It’s far more risky for a non-retiree to invest heavily in stocks at a time of high valuations than it is for a retiree to invest heavily in stocks at a time of overvaluation, in my assessment. I say “Yes!” to stocks during retirement but “No!” to overpriced stocks at all times.

Rob

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Neal@WealthPilgrim December 23, 2009 at 8:56 AM

I agree Rob. The perceived risk is defined by the short-term even though the goals are long-term.

The MF’s (Motley Fools) wrote an article playing to those fears (see comment below). That just bugs me.

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steamboy October 30, 2011 at 6:36 PM

i will receive about 2/3 of my retirement income from pensions. my thinking is that there is a goodly portion of bonds and fixed income products in those pension portfolios. therefore my personal investments are 100% in equities (albeit safe dividend increasing equities). i may be making some logic error here but it seems right to me.

Reply

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