Last week we got a taste of something that we haven’t experienced in awhile: Volatility. A wave of anxiety swept through the markets, pushing the Dow into negative territory for the year and handing the S&P 500 its worst week in two years.
What is causing the selling? There are plenty of headlines to choose from. Argentina is close to (another) default. Israel and Hamas are fighting in Gaza. Tensions in Ukraine have continued to worsen. The economy in Europe is sluggish. Banking issues are percolating again in Portugal. And above all of these, it seems, is the fear that the Fed will soon reverse course and begin to raise interest rates.
I have no idea if this is the beginning of a broader selloff or just a temporary breather before markets quickly resume their march higher. One thing I do know, however, is that markets have had five years of uninterrupted gains. Anytime that happens, it’s easy to become complacent with your investment portfolio and that complacency can be a very dangerous thing when you’re close to (or in) retirement.
With that in mind, let’s pretend that the recent volatility is a canary in the coalmine, warning us of a major pullback. What can you do to protect your nest egg?
As I said earlier, after 5 years of gains it’s easy to become complacent and just assume that the path of least resistance is higher. If history is any guide, however, we’re long overdue for a correction. How would your portfolio fare if the markets dropped 10%? How about 20%? Or what if we have a repeat of 2008 and they dropped nearly 40%. Would that affect your plans for retirement? If so, some changes may be in order.
Stock and bond markets rarely move in lockstep. Sometimes stocks outperform. Sometimes bonds. One consequence of this is that, left untouched, your portfolio will gradually get out of balance. The longer this imbalance is allowed to persist, the worse it gets. Take a look at the percentage of your portfolio that you have allocated to stocks and bonds. If the relative outperformance in stocks has resulted in that balance being skewed toward stocks, you should consider rebalancing back to your intended allocation.
Of course rebalancing will just get you back to your prior allocation. It’s probably worth asking if that prior allocation is still appropriate for your current circumstances. You’re five years closer to retirement than you were in 2008. A major downturn now might actually derail your plans rather than just causing a bit of anxiety. Rather than rebalancing to a prior allocation, it might be more appropriate to change your allocation altogether. If you’re really close to retirement, you might also consider setting aside a year or two of your expenses in cash so that you can minimize any potential sequence risk (the risk that you will experience negative returns early in retirement).
Those are just a few proactive ways to deal with the inevitable volatility that is part and parcel of our financial markets. For other ideas on how to keep your plans on track you can read this: Anxious? Focus on what you can control.
Next up: I’ve been getting a lot of questions about bonds lately. What if the Fed starts raising rates? How much of my portfolio should be allocated to bonds? What types of bonds are most impacted by rising rates? I’ll dig into those questions and more in my next post.
Have a great week.
Have you ever noticed that the time it takes you to do something expands to fill the time you allow yourself to do it?
I see this most frequently at work. If I have 5 tasks to do and all day to do them, it takes me—surprise!—all day. If I only have half a day to do the same five tasks, however, I am somehow able to check them all off my To-do list before lunch.
I don’t think I’m alone in this. You do it too, right?
Too Much Runway
With that in mind, think about your retirement. The typical retirement age is 65, which means we give ourselves about 45 years to get “Retirement Ready.”
At the risk of stating the obvious, forty-five years is a LONG time. Too long. Giving yourself that much runway almost guarantees that you will procrastinate and not take things very seriously. After all, there’s always next year (or next decade).
What would happen if you only gave yourself 40 years? Or 35? Or 10? Answer: You’d be much more serious about hitting your goal. You’d save aggressively, spend intentionally and invest wisely. How much could you shave off the typical 45-year timeline? Let’s look at an example.
Ben and the Incredible Shrinking Career
We’ll need to make some assumptions here, but just keep in mind that the end result is more important than the assumptions. Let’s say you have a 20-year-old guy named Ben who wants to retire with $1 million. Let’s assume the markets return 8% per year and Ben makes $50,000 per year throughout his entire career and never gets a raise.
Given those criteria, if Ben saves about 5% per year he will hit his $1 million goal in 45 years. But what if he saves more?
Save 10% = Retire in 37 years
Save 15% = Retire in 32 years
Save 20% = Retire in 28 years
Save 25% = Retire in 26 years
So Ben could retire in his 40s or 50s instead of his 60s if he decided to spend his money on mutual funds instead of mojitos.
I’m guessing I have exactly zero readers that are 20 years old, but the above math can apply to you as well. Sure it won’t be as dramatic because you don’t have as many years as Ben, but you’re also not starting from $0, you’re in your prime earning years, your kids are grown and if you’re over 50 then you’re eligible to make catch-up contributions to your retirement accounts.
You probably won’t be able to shave 20 years off, but could you shave off one? Five? Seven? Each year is a year you can spend with your spouse and friends instead of your boss or that difficult client. It’s a year you can spend seeing the world instead of staring at your cubicle. It’s a year you can spend sitting at the beach instead of stuck in meetings.
With so many people behind on their savings, retire later is a common piece of retirement advice. Given human nature, however, retire early might yield better results. And don’t forget…
Life is short. Be intentional
Quick note on a sale we’re having: You may have noticed that I recently opened a store at Intentional Retirement. Almost everything I do at the site is free, but I do have a few things for sale (and several new products on the way). To celebrate the opening, I’m having a sale on the current flagship product, the If Something Happens to Me Kit. Thousands of people have purchased the kit over the years as a tool to fill holes in their planning and organize their financial, legal and insurance affairs. Through Friday of next week (June 28), if you purchase the kit, I’ll throw in a free copy of my book The Bell Lap: The 8 Biggest Mistakes to Avoid as You Approach Retirement (normally $14). A few questions you might have:
Q: If I buy multiple copies of the kit, do I get multiple free copies of the book?
A: Yep. Buy some for friends and family.
Q: Can I forward this email to anyone I know who might be interested?
Q: Will the free book show up in my order details when I place the order?
A: Nope, but it will be in the box when your order arrives
Q: What if I have some other question?
A: Just email me at firstname.lastname@example.org or give me a call at 1-888-391-4344
And now a look at rising interest rates…
How rates got so low
In response to the global financial meltdown in 2007-2008, the Federal Reserve lowered short-term interest rates to historic lows in an effort to stimulate the economy. When that didn’t seem like enough, they started a program of “Quantitative Easing” where they began buying bonds in an effort to lower rates further.
As you might imagine, when a buyer shows up and says “Give me a few trillion dollars of those” the price of “those” tends to rise (more demand = higher prices). With bonds, when prices rise, rates fall. So as the Fed artificially pushed up prices, rates fell further. That was good news if you were borrowing money for a house. Bad news if you were trying to earn a little interest on your money market or CDs.
Investors responded to the 2007-2008 crisis by shifting a disproportionate amount of their money from stocks to bonds. Seeing your stock portfolio drop by half can go a long way toward making you a lover of all things fixed income. With everyone buying bonds, prices rose further and rates fell further. So that brings us to today, where rates are extremely low and most investors are overweight bonds.
What happens when rates rise (as they have started to do)?
Of course the Fed can’t keep printing money and using it to buy its own debt forever. “Wouldn’t be prudent” as Bush 41 would say. When the economy gets better, Bernanke has promised to take away the punch bowl. When that happens, the biggest bond buyer in the market will put away its checkbook and those artificially high bond prices will start to fall. As prices fall, rates will rise. Said another way, all those bonds that people have bought over the last 5 years could start to lose money.
How can I protect myself?
Chairman Bernanke came out this week and said that the economy is looking healthy enough that the Fed will likely wind down its QE program by the middle of next year. Right on cue, rates started to rise and bond prices fell. So how can you protect yourself against rising rates?
First, review your asset allocation. As I said earlier, many investors swore off stocks after 2007 and shifted most of their money to bonds. That could expose them to significant losses if bond prices fall. Look at your portfolio and see what percentage is in things like bonds, stocks and cash. Work with a trusted adviser to make sure that the balance is appropriate for your circumstances and risk tolerance.
Second, review the duration of your bonds. Not all bonds respond the same to rising and falling interest rates. Duration measures how sensitive a bond is to a change in rates. The higher the duration, the more sensitive the bond. If a bond (or bond fund) has a duration of 10, it will typically fall in value by 10% if rates rise by 1%. If it only has a duration of 3, it will fall by 3% if rates rise by 1%. It stands to reason then, that if you expect rates to rise, you should gravitate toward lower duration bonds.
Third, don’t panic. Markets tend to overreact. Rather than focusing on the daily headlines, the best recipe for a good night’s sleep is to make sure that you have a well balanced, diversified portfolio that is appropriate for your circumstances and goals.
Any other questions about bonds? Put them in the comments section below and I’ll do my best to answer them. Have a great weekend!
The retirement question most people seem intent on answering is “How am I going to pay for it?” That’s an important question, of course, but retirement is more than just a math problem.
In my opinion, we spend too much time thinking about how to get there (math) and not enough time thinking about what we’re going to do once we arrive (meaning). If you focus solely on your finances, you risk having a retirement that is cash rich and lifestyle poor.
Cash is great, but it’s not the end goal. Your money is nothing more than fancy paper that our government has created to make commerce and exchange easier. The end goal is not to have money. It’s to use that money to do things that you really care about; things that provide joy, meaning and fulfillment. If you do that, then money (contrary to popular opinion) CAN buy happiness. Let me show you what I mean. I’m assuming you’re all familiar with the mathematical proof: If A=B and B=C then A=C.
Applying that to our discussion:
- If money=control
- And control=doing what fulfills you
- And doing what fulfills you=happiness
- Then money=happiness.
Of course that transitive logic only holds true if you use the time you control to do what fulfills you. Which brings me back to my original point: If you want a meaningful retirement, then you need to treat your planning like more than just a math problem. You need to decide what it is that you really want out of life and use whatever resources you have and time you control to pursue those things. Are you doing that? If so, great. If not, spend some time thinking about what it is you actually want to do with all that money you’re saving.
Have a great week.
Just like it’s a good idea to get a health checkup every year, it’s a good idea to get a financial checkup as well. Doing so can help you detect problems early (while they’re still treatable) and will also help you gauge your progress and make sure you’re on track for a healthy retirement.
To help, I put together this Financial Checkup Checklist with areas that you should be reviewing. Go through it and then touch base with me if you have any questions or there’s anything I can help you with. Have a great week!
If you work with a financial adviser, it’s a good idea to get together at least annually to review your accounts. As we get ready to transition into a new year and as our government grapples with the issues surrounding the “Fiscal Cliff,” now may be a good time to call your adviser and schedule that meeting. Below are seven questions you can ask to make sure that your retirement planning stays on track.
Are there any actions I need to take before the end of the year? Most of the questions below can wait until next year, but for obvious reasons, you need an answer to this one before December 31. With changes expected to both dividend and capital gains taxes in 2013, review your holdings and ask your adviser what actions, if any, you should be taking before yearend. Also, if you are 70 ½ or older you will likely need to make a Required Minimum Distribution (RMD) from your retirement accounts before the end of the year.
How did my investments perform relative to their peers? It is difficult to gauge performance by returns alone. If your stock mutual fund drops 20 percent does that mean that it’s bad? Not if similar funds dropped 40 percent. When monitoring performance, it’s important to have either a benchmark or peer group that you’re measuring against. Your adviser should be able to review your holdings and see if the managers you’ve hired are earning their fee. If so, great. If not, changes may be in order.
Is my asset allocation still appropriate? Your portfolio is likely made up of a variety of different asset classes such as U.S. stocks, foreign stocks, small cap stocks, government bonds, corporate bonds and municipal bonds. How much you have in each area is referred to as your asset allocation. The balance will vary based on a number of factors such as your age, risk tolerance, goals and outlook for the global economy. As your circumstances change and as market movements alter your allocation, it is important to meet with your adviser and rebalance your holdings to get them back in line.
Is the amount of risk I’m taking still appropriate? Investing too aggressively can result in significant losses to your portfolio. Investing too conservatively can mean that your investments don’t keep pace with inflation. Either of those outcomes will reduce the purchasing power of your money in retirement. Work with your adviser to make sure that the amount of risk you’re taking is still appropriate for your circumstances.
Am I saving enough? There are a number of assumptions that go into calculating how much you need to save in order to retire. Even small errors in those assumptions can have drastic changes in the predicted outcome. Rather than making a plan and then waiting 20 years to see if it works, it’s important to make small adjustments along the way. With each new year, you have new information relating to things like investment returns, savings rates and taxes. It’s important to evaluate that new information and ask your adviser “Based on these new realities, am I still on track to reach my retirement goals.” If the answer is no, talk through any needed changes.
Is my withdrawal rate sustainable? Of course, this question is only appropriate if you’re already retired and drawing income from your portfolio. Running out of money is a major fear for many retirees. To avoid that problem, it is important to have a sustainable withdrawal rate. A suitable rate depends on a number of factors including investment returns, inflation, longevity and even luck. A popular rule of thumb is to limit withdrawal rates to 4 percent, but everyone’s circumstances are different, so work closely with your adviser to make sure your income lasts.
Do you recommend any other changes? A good adviser is realistic and honest. Rather than telling you what you want to hear, he or she is paid to give you straightforward advice that will help you accomplish your goals. Not only that, but a good adviser should be able to look at your total financial picture and offer comprehensive advice. Take advantage of that knowledge and experience and ask what, if any, other changes are necessary.
The annual review is an important element to the client-adviser relationship. It is an ideal time to evaluate performance and make necessary adjustments to help you reach your retirement goals. Pick up the phone and schedule a meeting today so you can start the New Year off right.
I originally published this article at www.fpanet.org.