At some point in retirement, your challenge is replacing your salary or business income with Social Security, possibly pensions, and income generated by your nest egg. Odds are, you’ll come to the point when you need your retirement nest egg to provide significant income every month for the rest of your life. Whether you’ve accumulated $500,000 or $50 million, it’s critical that you manage your nest egg to provide your desired income for life and an adequate cash reserve — all with some certainty.
How do you do this in the face of volatile markets, falling bond prices, and rising taxes?
Many people think that if their assets grow enough, they’ll have enough income for life. It’s important that you understand that the market is a great place to grow money, but a very challenging place to withdraw money. That’s why a custom financial plan is required to provide a high probability of tax-minimized lifetime income.
Outdated traditional financial planning is based on the Modern Portfolio Theory and the Efficient Frontier.
These concepts suggest that there is some optimal combination of stocks and bonds that offers the highest returns at any given level of risk. Used as an investment strategy, it provides no protection of sequence of returns risk and running out of money.
The Modern Portfolio Theory was intended to apply to large, ongoing pools of money, not individual investors who, on their own, need income from investments over a specific period of time.
According to The American College, current research shows that there is “a better efficient frontier” — a better way to invest that offers higher returns and more predictability of income.
This better approach is accomplished by replacing much of the bond portion of the portfolio with a “risk-free asset.” This may sound counterintuitive, but here’s what makes this approach so powerful:
- Adding a “risk-free asset” provides greater predictability of lifetime income because the risk-free asset can be used for income needs if and when the risk portion is down (i.e., a market downturn). This way, you don’t lock in losses. Remember, the goal is to always sell high.
- Certain risk-free assets can provide dependable lifetime income. Once income is insured, then reserves can be invested for high growth. Volatility is less damaging since there is no need to withdraw money from the market each month. This freedom to access withdrawals from a volatile market portfolio when the account is up allows for greater overall growth and removes sequence of returns risk!
- Certain risk-free assets have outperformed some long-term consumer stock and bond portfolios.1
Obviously, a retirement plan needs to be designed for your goals, challenges, opportunities, and realities, but having the knowledge of advanced planning tools, like “a better efficient frontier,” allows Heafner Financial to create a more effective plan.
1Dalbar QAIB Study – 2013 Mutual Fund Returns vs. Investor Performance