Many of us have heard or seen the stories from people we know. A former colleague had plans to retire but could not do so because a significant position in the stock of his employer unexpectedly took a large tumble and may not recover.
Or, you may have heard about an acquaintance who thought about retiring in 2008 but whose investment portfolio ended up declining by 50% from late 2007 to 2009. That person lost their job during the “Great Recession” (as it is now called) and had to entirely scuttle their plans before they could again reconsider retirement years later.
Cautionary Tales
These fictional stories are examples of how poor investment results can tragically derail people’s financial plans. They might be disturbing to read, especially for many people I meet who are mid-life professionals in the midst of job loss or professional transition or who are thinking about retirement.
I also understand that there may be other reasons today’s world of investing and finances can bring up anxiety and uncertainty, perhaps more so than ever. The US and many parts of the globe are still in a battle with the formidable coronavirus (although uneven progress is occurring).
The economy is coming back from a historic downturn but has a long way to go before financial conditions return to the pre Coronavirus level of economic activity.
Investments across the broad spectrum of asset classes (equities and fixed income) are likely expensive when compared to their 30-year historical averages, which may result in lower returns than what we have seen in the recent past.
The Good News for Your Financial Future
Although this outlook sounds pessimistic, I am actually writing to share good news! Despite all of the questions we may have about today’s world, and perhaps even the unknowns about your own situation, I am very confident that those of us in mid-life can confidently position their investments to move toward their lifestyle and financial goals. They may very likely be able to do so without feeling financial anxiety.
No, I am not crazy! There are always unknowns about the state of things around us, about what may occur in our own lives and how these events could impact our portfolios. And although that uncertainty may be greater today than ever before, proactive financial planning offers the potential for people to positively move forward. In my opinion, you do not even need to buy a crystal ball or need to become a soothsayer in order to develop an investment strategy that fits your financial goals.
Instead, years of personal and professional experience have taught me the importance of beginning to plan for your financial future during a time of mid-life change. As you approach your 50s and 60s, the timeline to retirement does move closer.
There are also planning considerations for those in transition; considering a career pivot; thinking about a “working retirement” or even pursuing a completely new professional path before eventually leaving the world of work.
Comprehensive Financial Planning Might Solve Investment Riddles
The process of planning for the next life stage requires a focus on many long-term financial and investment management considerations. I have recently written articles about two important “building blocks” in doing this kind of analysis: longevity planning (making sure you do not outlive your money) and preparing for inflation and higher healthcare expenses.
Today’s article is a discussion about a third important pillar of this work, which is investment planning. Warning: I have no advice about the next hot stock or asset class which is a sure bet to beat the market over the next 18 months!
But I do have strong opinions and practical advice about how people can confidently craft investment strategies to reflect a future that may be quite different than their past. And yes, this can actually occur while you are experiencing professional change and while recognizing the reality that we cannot reliably predict market movements or performance over the long-term.
There are three key ingredients necessary to build a sound investment plan and strategy for this life stage:
- Anticipating and Projecting Your Portfolio Withdrawals
- Setting Realistic Expectations About Investment Returns
- Considering Your Own Feelings About Investing and Risk
Anticipating and Projecting Withdrawals
Before you can evaluate your current investments and whether they are appropriate for your next life chapter, I highly recommend that you consider preparing a detailed projection of your household finances and cash flows (or hiring a financial advisor to do so).
I have written about the benefits of this kind of comprehensive financial planning if you wish to learn more about it. In short, seeing and visualizing your income streams and expenses over future years provides an amazingly effective framework for approaching a range of strategic decisions across the financial spectrum, including your investments.
This projection is essential for many reasons, not the least of which is that you will understand how much money you will need to withdraw from your portfolio after you stop working. Understanding this information before you leave work is critical in order to remain confident about the long-term sustainability of your retirement.
However, to develop an effective investment plan and strategy, a deeper understanding of your cash flows is necessary. Over time, withdrawal rates will change in your portfolio. In fact, some of your investment accounts will face larger withdrawal rates as you age even if you do not need the money, while others you might not even touch.
Impact of Changing Withdrawal Needs
Understanding these shifting withdrawal rates over time from your 401(k) plans, IRAs and taxable investment accounts will help you approach the really important decisions such as whether your objectives should be primarily focused on capital appreciation, income, capital preservation or a combination of the three.
These broad investment goals provide an important framework for investment decision-making. For example, accounts that may be subject to larger withdrawal rates, especially in the early years of retirement, may be better suited to a capital preservation and/or income objectives. However, capital appreciation or aggressive growth may be a more appropriate objective for accounts that may have lower or no withdrawal needs at all.
Once you make these broad decisions about your investment objectives, you can dive deeper into exploring more detailed questions such as the appropriate asset allocation for each of your accounts, and ultimately security selection.
The asset allocation decision is crucial. The mix of the equity and fixed income investments in your portfolio may have by far the greatest influence on the returns and volatility of your portfolio over the long-term, rather than the specific securities you purchase, according to years of academic research.
Set Realistic Expectations About Returns
Although I generally consider myself to be an optimist, I recommend caution when thinking about future returns in the financial markets. This is not because I have a point of view about the potential performance of the broad equity and fixed income asset classes or that I think returns in the near or medium term will be poor.
My opinion is that such predictions are unknowable. Instead, I think prudent planning requires making assumptions based on the likelihood that conservative assumptions may likely give your plan a higher probability of success than making assumptions that are closer to long term market history.
For example, over the past 10 year period ending October 30, 2020, one broad measure of the US stock market, the Russell 3000 Index had an average annual return of 12.8%, according to LPL Financial. This return is far greater than historical returns of 8% to 10% annually for the stock market, depending on the time period used.
In my opinion, it would be unwise to assume such returns moving forward, even the historical rates of return. In the event that the markets provide lower than average returns, especially over the next 10 years, a more conservative set of assumptions used in your financial plan may likely increase the chances that your financial plan will be successful over the years ahead.
This is especially important because today’s relatively high valuations may lead to returns which are substantially lower than what we have experienced over the past 10 years.
Of course, there is no guarantee that making conservative assumptions based on history will be conservative enough! But I think a better starting point is to assume lower returns than historical averages since this may make your plan more durable. You might have more money left in your later years if returns are closer to their long-term averages, but that situation is far better than your money running out before you do because your assumptions were too optimistic!
Consider Your Risk Tolerance
The third investment consideration is your own risk tolerance. Sometimes, people who have done a very good job of saving for retirement may only need to withdraw a small percentage of their portfolio savings over many years. These individuals have the financial capacity to take on more investment risk or to have a primary focus on capital growth if they so choose.
However, that does not necessarily mean that they should establish and continue with investment goals focused on growth. A critical part of the investment process is that you should consider your own feelings about market fluctuations and the investments which make you more or less comfortable with your investment strategy.
Taking less investment risk is not necessarily a bad thing, especially if it helps you sleep better at night!
Simplicity Rules!
The world of investing and financial planning is indeed complicated. But like many things in life, the strategic decisions may only have to be as complicated as we choose to make them. Important financial and investment planning principles such as those discussed in this article provide a very useful and effective framework for approaching all kinds of financial decisions including your investment strategy.
You do not have to predict the future or become the next Warren Buffet to feel confident about your future and to move toward the next exciting chapter(s) of your life!
