3-2-1 Newsletter (8-13-2020)
Allow me to share these 3 insights, 2 findings, and 1 task for the week.
3 INSIGHTS FROM ME
I. 3 simple things will determine your retirement success
Awareness around what it looks like and if and when it's feasible
Acknowledgment of what needs to occur to turn vision into reality
Action that rationally informs how to meet goals and manage risks
II. 4 things to consider to maintain retirement security
Making retirement affordable is probably at the top of most people’s list. But once they're retired, keeping it affordable rises above all else. This should come as no surprise as maintaining spending power through retirement is crucial to meeting goals and preserving security.
To help you preserve spending power, let's take a look at 4 stalwart strategies that should be a part of your retirement.
Retirement Income Plan
The evidence is clear that doing the upfront homework to build a comprehensive retirement income plan leads to better outcomes. This includes placing investments in their proper perspective as just one of the many important parts of the plan and considering other aspects of retirement such as your purpose, goals, risks, time horizon, spending flexibility, and so forth.
Ensuring your portfolio is appropriately spread among the various investment types is one of your smartest moves to reach retirement investment goals. Establishing and regularly rebalancing to the proper mix of stocks, bonds, and cash will ensure the right amount of risk is undertaken to reach goals. This can help anchor you to an investment strategy designed solely to reach retirement goals and not chase market returns.
Dynamic Spending Strategy
If you're not adjusting your spending to the market, you could spend yourself right off a cliff if market conditions aren’t friendly over certain periods of time. One approach to combat this is a dynamic spending strategy where portfolio withdrawals are increased or decreased based on market rises and falls. Curtailing spending in years when the markets are not doing well has been shown to dramatically enhance the life of the portfolio. A market-sensitive spending strategy can have a dramatic effect on the long-term viability of a retirement plan.
An often overlooked aspect of retirement income planning is tax efficiency. And just like a market-sensitive spending strategy, chances are most people probably aren’t thinking about how to increase after-tax income. When we think of tax efficiency it's helpful to think about it in two ways: asset location and withdrawal order.
We’ve all heard of asset allocation: where to put money between stocks, bonds, and cash. Its counterpart asset location is really just a strategy that determines the most tax-friendly place (taxable, tax-deferred, or tax-free) for each type of investment. For example, taxable bonds tend to be much less tax-efficient than index stock funds because they generate taxable interest payments and are great candidates for tax-deferred and tax-free accounts.
The other side of this is a tax-efficient withdrawal order or spend-down. That’s when you’re actually taking money out of the accounts. The predominant place where most save assets is in retirement accounts, whether it’s an IRA, small-business-type plan, or a 401(k). The natural inclination would be to take the money from the place you've spent your career saving money. However, from a tax efficiency standpoint, the best move is to spend from taxable accounts first and save those retirement accounts for as long as possible to get the benefit of the tax advantage.
III. How you spend determines how long you spend.
At first glance, it's not apparent why that's true, but unless you're adjusting your retirement spending to the market, you could spend yourself right into the poor house if market conditions aren’t favorable over certain periods of time. That's because spending too much at the wrong time can deplete assets to the point where maintaining spending at levels needed to support the desired retirement is not possible.
This raises a key question: what level of spending is sustainable over retirement to meet targeted spending needs? Most people decide how much money to withdraw from their portfolio based on their income needs. The two most common withdrawal strategies are the 4% Rule and the Percent of Portfolio strategy. The 4% rule--dollar plus inflation-- is where you pick a percentage of the portfolio, spend that in year one, and then that amount is increased by the cost of living each year. On the other end of the spectrum, the Percent of Portfolio strategy has you pick a percentage and spend that percent of the portfolio every year, no matter what happens with the markets or inflation.
Selecting an income strategy is one of the most important retirement decisions you’ll have to make. When choosing a strategy there are three criteria to optimize for: 1) market sensitivity, 2) spending stability, and 3) portfolio longevity. Both strategies break down when compared against these criteria. The 4% Rule is stable, but it's not sensitive to the market. The Percent of Portfolio is sensitive to the market, but it's not stable because a fixed amount is withdrawn each year no matter how far its value has fallen from a down market.
A hybrid strategy that sits between the 4% Rule and the Percent of Portfolio strategy is the Dynamic Retirement Spending strategy, where spending is increased or decreased based on market rises and falls. Studies prove this strategy has a beneficial effect on the long-term viability of a retirement plan, as a small 2.5% decrease in spending in years when the market’s not doing well dramatically increases the longevity of the portfolio. When thinking about dynamic spending, it's about finding ways to decrease spending a bit during market downturns in exchange for increasing it during market upturns.
When we’re in a crisis like today, it’s something that retirees may want to consider; just making small course corrections throughout retirement can have a dramatic effect on long-term retirement security.
2 FINDINGS FROM OTHERS
I. Are Markets And The Real Economy Disconnected?
You’d have to question that after watching the markets (and your portfolio) shoot up while at the same time hearing about mounting bankruptcies, skyrocketing foreclosures and record unemployment. How can Wall Street be so rosy while Main Street is so dismal? According to a recent white paper from the American College of Financial Services, there are a handful of factors behind this trend:
Markets are forward-looking and the economy is backward-looking, meaning markets tend to price in expectations for future economic development while the economy reflects things that have happened in the past.
Markets are dominated by a handful of technology companies like Apple, Microsoft, Amazon, Google, and Facebook. These companies have all done well and have driven most of the market rally over the last decade, and are largely responsible for the more-recent rally from the market’s mid-March lows. Furthermore, only 1 percent of companies are listed and don’t accurately represent the broader economy that comprises the bulk of companies.
The Federal Reserve has enacted extraordinary measures to counteract the pandemic that has indirectly made stocks more appealing than other investments such as bonds. This coupled with near-zero yields on safer debt instruments, such as government bonds, is pushing investors away from these assets to riskier assets, including equities. As investors flock to stocks, prices and the market itself naturally rise.
Source: Are Markets And The Real Economy Disconnected?
II. When Are People Claiming Social Security?
With traditional retirement income sources under constant threat, from vanishing pensions to declining portfolio balances, Social Security has taken on a larger role of retirement security to more Americans. With this added burden comes heightened importance on maximizing its impact through increased benefit amounts. The strategy commonly used to accomplish this is delaying Social Security claiming to at least age 70.
Based on the 2015 Annual Statistical Supplement to the Social Security Bulletin, it appears more and more Americans are embracing this strategy. According to the bulletin, those claiming benefits at 62 fell from 52% in 2005 to 37% in 2014. Meanwhile, those who delayed claiming until past their full retirement age rose to 9% in 2014. These numbers clearly indicate most Americans are heeding the advice to delay claiming Social Security for as long as possible to increase benefits.
With more Americans relying on Social Security to fund their retirement, it’s becoming increasingly important to maximize its benefits. This begins with having a Social Security claiming strategy that prioritizes delaying benefits as long as possible to secure the largest benefit available.
Source: When Are People Claiming Social Security?
1 ACTION FOR YOU
I. Determining the role of work in retirement.
Prudent retirement income planning begins with identifying and implementing the actions necessary to support the goals while protecting against risks that stand in the way of those goals. Undertaking the right actions consistently before and during retirement is crucial to your golden years.
We’ll look at one action item to take and reveal a new one each week.
This week’s action: Work in retirement. Retirement can mean many things to many people. To some, it’s the end of all paid employment and to others, it's a phased transition to a life of leisure or work at a reduced level. If working during the golden years is a part of your retirement plans, you’ll need to think through a few things before finalizing that decision.
Here are a few questions to consider:
- What type of work are you likely to choose?
- What are your reasons for doing it?
- How much are you likely to earn?
- How long do you think you might continue to work?
- Are you planning to do volunteer work? If yes, what would you like to do?
- What is driving you to do volunteer work?
Have a Question? Want to chat about it?
Until next week,
Mark Sharp, CFP® RICP® EA