“Good judgment comes from experience and experience comes from bad judgment.” I’m not sure who said that, but it sure is true. When considering investment lessons learned from the financial train wreck of last few years, many people at or near retirement are likely to put the arithmetic of loss at the top of their list. Unfortunately, this knowledge (like that gained from touching a hot stove) usually comes at a painful cost.
To see what I mean, imagine you had a $1 million portfolio that lost 20 percent, or $200,000, in a given year. Gaining 20 percent the following year would not get you back to even. A 20 percent gain on $800,000 would only get you to $960,000. You would need a 25 percent gain to fully recover from a 20 percent loss. The greater the loss, the more difficult it becomes to get back to even. If you lose a third of your portfolio, you need a 50 percent gain to recover. Losing half of your portfolio means that you would need to double your assets just to get back to where you started. Those types of gains take time, which is fine if you have thirty years to go until retirement, but not if you have three.
When you understand the math, it is easy to see that one of your primary concerns as you approach and enter retirement should be avoiding large losses. Large losses are extinction level events. They are like meteors to dinosaurs. They can wipe you out. All else being equal, the closer you get to retirement, the more conservative your asset allocation should be. Take a minute to review your allocation. Is it appropriate for your circumstances or is it the financial equivalent of “Put it all on red”?
Chances are you’ve been asked that question before. Maybe by your spouse or a co-worker. Maybe by your kids. When someone asks you that question, is the answer you give a date or a dollar amount? For most people it’s a date. Something like “March of next year.” or “When I’m sixty-five. Two years to go!”
When you think about it, though, your age has very little to do with it. Sure, you can start taking Social Security at 62, but the average Social Security payment couldn’t lift you above the poverty line. If you’re like most, your nest egg will be doing the really heavy lifting during retirement. It will take over the job that the payroll department handled while you were working. So instead of basing retirement on your birthday, consider basing it on your bank account instead. Figure out the amount of money you need in order to generate the annaul income you require to fund the retirement you want. Get that amount saved and you’re retired, regardless of how old you are or whether or not you are still working.
At almost every stage in life, you need to answer three crucial questions. How you answer them will influence the arc of your life for decades to come. What are they?
1) Where do I want to live?
2) What do I want to do?
3) Who do I want to do it with?
Think back to the previous times in life when you answered those questions. Maybe it was when you were heading off to college or entering the workforce. Maybe it was when you got married and started a family or maybe it was when you had a career change. Knowing what you know now about how each decision shaped and influenced your life, can you see how important your answers were?
As you plan for and enter retirement, it’s time once again to ask and answer “The Big 3.” Block off some time on your calendar to think – and I mean really think – about those questions. How you answer them will largely define how you spend the final third of your life. And if you feel like sharing what you come up with, post a comment below. It might just serve as insight or inspiration for the rest of us.