Is it starting to feel a little bit like the beginning of another 2008? If not, it probably will whenever the next 1,000-point plunge hits. About this time, every 7-8 years or so, investors start to remember that markets don’t only go up. It can be hard to face that reality. This hope typically stems from the desire to make money. However, that desire is typically rooted in a buy-and-hold strategy, which can only make money when markets go up. A strategy that can only make money when markets go up, and with the understanding that markets go up and down, seems a bit problematic, right?
What most retirees and near-retirees don’t know is that there are three principles in retirement planning that help people like you sail through these turbulent times, like right now, without having to even change travel plans. If markets go down 50%, and you following these principles, it probably won’t matter if you’re at home hosting brunch with some friends or on the beaches of Bora Bora.
Principle 1: Only draw income from principal guaranteed sources
The biggest mistake retirees make is assuming that markets will only go up. If that were true, none of today’s major concerns would exist. When markets go flat or down, it not only compromises the investment returns you were depending on, but it also makes your income very expensive.
The technical term is called sequence of return risk. It basically means, when markets go down, you are accentuating your losses, making them worse. This is the major reason people in 2008 had to “retire” from retirement and go back to work. Had they following the first principle, “Only draw income from principal guaranteed sources”, or in other words, only draw income from sources that can’t lose money, they could have avoided the financial ruin that cursed so many.
Principle 2: Use a distribution plan
Many retirees make the mistake that a plan to distribute assets is technically a distribution plan. The same would be saying a square is a rectangle, but a rectangle is not always a square. Confused? Let me explain.
A distribution plan is a written plan that articulates how much money you will get each month, net of tax for as long as you live. It also breaks out different groups of investments so you know what investments will pay your income from year 1 of retirement to year 5, for example. These other investments will grow for 5 years and then pay you income from year 6 of your retirement to year 10. By following the first principle, and by mapping out your income in this form, you can see clearly how much you can draw without running out of money before you die.
It is also important to note that by implementing these first two principles, you can see that you are able to sail through market turbulence without worry of going back to work. For most retirees, this clarity is a top priority.
Principle 3: Diversify by purpose using the investment triangle
At this point, the most common question asked is, “does this mean I should put all my assets in principal guaranteed accounts and ladder them?”. Absolutely not. There are many goals a retiree can have. Some of the more common goals, aside from income stability, is tax minimization and/or growth for legacy. You cannot effectively accomplish these goals if you have all your assets in principal guaranteed accounts. This is why the third principle is so critical, “Use the investment triangle to diversify your assets.” The investment triangle is a tool that helps you diversify your assets by purpose, not just by risk.
Diversify by risk, for the record, is essentially based off of two data points; your age and your declared risk tolerance. When you have goals of income stability, tax minimization, legacy growth, risk reduction, and so much more, simply diversifying by risk is not enough. This is where the investment triangle comes in.
The investment triangle uses the three characteristics of any given investment to help lead you to how you will diversify your assets. For example, every investment can offer either growth, liquidity, or principal protection. Here’s the catch, you can only pick two of the three characteristics. There is no one-size-fits-all investment. It does not exist. When you use a little of each category, then you can have your cake and eat it too, so-to-speak, with your retirement plan. Let me walk you through it…
Investments that are liquid and principal protected make great accounts for emergency cash funds. They are readily available and they can’t lose value. Investments that are principal protected and grow tend to be suitable investments for mapping out your income for the next 10 to 20 years. In retirement, you need income now and later. Giving up some liquidity to map out your income, while following the first principle is appropriate. Not all of your eggs are in this basket. The third option is liquid investments that grow. Because these investments have the highest risk, they also offer the highest potential return. Because they also have the highest downside (the have risk), they are also liquid. These accounts are best suited for long-term investment goals. Just like when you were working and had a 401k, your account went up and down, but overall there was probably more ups than downs. Because you didn’t take income from this account, it was able to grow better, especially over a long period of time.
When implemented correctly, all three principles can help you avoid the next big downturn without sitting in cash. Retirement is meant to be the golden years of your life. If you wake up each day nervous about whether you can stay retired or not, your emotions would suggest you don’t have a plan that is suitable to you. If the market ups and downs affect your mood, your emotions would suggest you don’t have a plan suited for you. Don’t take the reactive approach to retirement, build a principle-based plan that can alleviate your stresses and pain points so you can enjoy your golden years how you had always intended.
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