4 Questions to Answer Before Creating Your Retirement Portfolio
William Bernstein is a student of financial history. He generously shares investing knowledge through his writing and speaking. Such was the case when he was recently interviewed on Morningstar’s The LongView Podcast, promoting the release of an update of his investing classic The Four Pillars of Investing.
This interview packed a lot of wisdom into a relatively short conversation. There was one downside. The format didn’t give much time to zoom in on any one specific topic.
I would like to do that with one topic that is particularly relevant to readers of this blog. Bernstein briefly discussed four questions anyone approaching or in retirement should be able to answer to effectively build and manage their portfolio.
What is your burn rate?
I have a love-hate relationship with safe withdrawal rate research. On one hand, understanding how much you want to spend in retirement (NOT your income or a generic “magic” retirement number) determines how much you need to retire is foundational.
Using the inverse of the 4% rule informs the idea that you need approximately 25 times your annual spending to be financially independent. While not perfect, this provides a true north to work towards during the accumulation phase which many people find motivational.
This also drives the behavioral change of increasing saving for many people. It also helps illustrate the impact of fees on a portfolio. This leads people to educate themselves on investing and take control of their portfolios.
However, no one actually spends money in retirement as modeled in this research. As you near retirement there are better ways to determine whether you have enough. Using professional financial planning software or outstanding options available to individual investors like NewRetirement PlannerPlus or Pralana Gold (affiliate links) allow you to model anticipated expenses and income streams in retirement.
This is superior to assuming a constant rate of spending and a rate of withdrawal from a portfolio, adjusted only for inflation. However, Bernstein’s point is an important one.
You need to know:
- What is your starting burn rate?
- How will it change over time?
The lower your burn rate, the less aggressive you need to be with your return assumptions. Simultaneously, a lower burn rate allows you to afford being more aggressive with your investments. The higher your burn rate, the opposite is true.
Understanding this will help determine how you answer his subsequent questions.
How old are you? (I.e. What is your time frame)?
It’s important to have a realistic expectation of how long your retirement will be. Your portfolio must find a balance to last through that anticipated time.
It must be conservative enough to provide adequate stability. You can’t draw down too large a portion in a market downturn early in retirement. Your portfolio may not be able to recover (i.e. too susceptible to sequence of returns risk).
Simultaneously, you must take enough risk to provide adequate growth. If you don’t, a combination of your withdrawals plus the impact of inflation will slowly erode your portfolio (i.e. – too susceptible to inflation risk).
Related: Investment Risk — What You Don’t Know Can Hurt You
It is impossible to know exactly the right mix of investments to have in your portfolio. However, recent research shows that self-directed investors hold a far greater percentage of their portfolio in stocks at retirement age than:
- Target date funds that match their age.
- Age matched investors with managed retirement accounts.
Anecdotally, this is a trend I see consistently in near retirees, whether FIRE types or traditional. It is concerning.
It is worth spending some time considering how much risk you have in your portfolio. Is it time to take some risk off the table if you are approaching retirement?
What is your risk tolerance?
Your burn rate and how long you need your money to last are considerations of your risk capacity. Risk tolerance is more of an assessment of how you will fare mentally. How would you feel in a time of market volatility?
Because you have a very low burn rate and/or short anticipated time to support yourself, you may have a very high risk capacity. However, if the portfolio volatility that accompanies it would cause you to lose sleep at night, what’s the point of taking unnecessary risk?
If you actually act on your fears during periods of market volatility, your secure position can suddenly become precarious. So you need to be honest with yourself.
How many past bear markets have you been through? How did you behave?
Past behavior is probably the best indicator you can go on. However, it is not a guarantee of the future.
In retirement you won’t have new money coming in to invest when stocks are “on sale” in a downturn. With larger account balances, an equivalent percentage loss will equate to a larger loss in absolute dollars.
Both of these factors can drastically change the psychology associated with the same market event. Both are good arguments for being a bit more conservative as we get older.
This brings us to Bernstein’s 4th question.
How do you value safety vs. leaving a bequest?
This question applies to those that are confident that they have saved enough for a secure retirement, and likely have saved more than enough.
One way to consider this question is with a famous quote of none other than Bernstein himself. “If you’ve won the game, stop playing.”
What if you ran out of money in your 80’s? Or in the later stages of retirement you had to skimp by with limited options and not knowing if your money would last? How bad would that make you feel?
However, there is another school of thought. If you have both the risk tolerance and capacity, you can dial up the risk in your portfolio. Swing for the fences! If you have a low burn rate and non-portfolio sources of income (annuities, pension, Social Security, etc.) that cover most or all of your normal spending, this may be reasonable.
What if at the end of your retirement you were sitting on $10 million dollars? Or more? Where would you want that money to go? Would it be life changing for you or people or causes you love? How good would that make you feel?
For most people, there is significant asymmetry. The downside of the worst outcomes is worse than the benefit of the best outcomes. If that applies to you, it’s a good argument for dialing back risk, even if it means you will likely end up with a smaller portfolio to bequest to others.
However, if you have both the capacity and tolerance it may make sense to take more risk…. Or better yet, just start giving the money away sooner. Then you can have more impact on the beneficiaries and enjoy seeing the impacts of your gifts.
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]
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“Or better yet, just start giving the money away sooner. Then you can have more impact on the beneficiaries and enjoy seeing the impacts of your gifts.”
Something my wife and I are discussing now as we update our trust. While it’s nice to think about what our beneficiaries might get after we die, we’ve been thinking about a more immediate impact. when we were in our early 30s and my wife was gifted a few thousand from her grandmother. While that amount is immaterial to us now, it was very impactful at that age as we moved into our first house and were recently married. We’re studying up on the gifting tax rules now.
Love hearing people changing their thinking on this. Mike Piper’s book, More Than Enough, provides a short, practical guide for giving in a tax-efficient way. Here is a link to my short review.
I’ve been giving a substantial amount of cash to my kids every year at Christmas time for the last several years. For me, it makes the most sense for a few very important reasons:
1) My kids can use the money with their growing families NOW. I’m not going to worry how much they’ll need it 20-30 years from now. It most likely will not make as much impact then as now.
2) There are NO tax implications on the money I give them now. After I pass, they’ll have to pay taxes on my inherited IRA’s. Plus, they’ll have a clock ticking, forcing them to take the proceeds within 10 years.
Bottom line; I’d much rather give my money to the kids tax free now than have them give it to the government. Enjoy it kids!
On point #1. I love the sentiment and agree fully
One technical point on #2. If giving from your IRA there are tax implications for you the giver in that you will pay income tax on money taken from the account. Otherwise I agree here as well.
Thanks for sharing Joe!
Well, we’re comfortable right now in retirement. We’re both drawing Social Security (wife, who’s older, has maximized her SS, while I who contributed more, match her SS income.) We have a solid nest egg that is now stable, with appreciation pretty much matching our 401k/403b draws (even after the big hit from 2 years ago.) And we don’t have kids, so no obligation to pass onto the next generation. We’re looking at Required Minimum Distributions changing how we draw from the retirement accounts in the next 2-3 years.
BUT I don’t have a good sense on how to ‘value’ the risks of long term care. Wife has some orthopedic problems that could well put her in a wheelchair in a couple years. I don’t know how to cost out good long term care, and then to say “Here’s what we could do with the remainder for charitable contributions.” I have some thoughts about where to put that legacy, but don’t know how much to obligate in case we end up needing to ramp up our draws for quality long term care.
I suspect this is not uncommon, particularly for retired DINKs (Double Income/No Kids).
David,
I agree this is a tough question to answer for many people. In aggregate, this is an overblown fear and you can look at averages which are manageable for those that have saved and planned well.
However, we are individuals and not insurance companies. The case where you require care for long periods of time can be extremely expensive. Ideally, this is a situation you would insure, but this is a challenge with the current LTC insurance market so many people will be stuck in the predicament you are. Sorry I don’t have a better solution at this time.
Best,
Chris
This is a very helpful article. I’m in mid/late 60s still working. Always wondering how much is enough. Fidelity score says we’re good, but my gut says we need more. You are spot on re risk. Been thru multiple losing years and didn’t blink, but once retired, I think I will be more concerned re losing years. Do you give suggestions in articles about ‘safer’ portfolios for retirees? thanks for this article.
Joe,
One concept I find compelling is that of a “reverse glide path“. The idea in a nutshell, is starting less aggressive to protect against sequence of returns risk, and then actually increasing your equity exposure over time as you get older. However, this comes with trade offs as does any approach. One is that if you have good returns early in your retirement, you’ll be worse off with this strategy. Another is that it goes against all conventional wisdom and I’m not sure how many people would have the stomach to actually increase stock exposure later in life. Still it is one example worth at least exploring.
Best,
Chris
Having gone thru the Dotcom, GFC and retiring in March 2020 my understanding of my risk profile is quite clear and has 3 part distinct parts
ABILITY to take risk distills time horizon, human capital, years left in the workforce, income, expenses, liquidity and overall financial resources into a simple answer, usually, Yes or No. Its rational & quantitative like numbers in a spreadsheet.
WILLINGNESS to take risk measures gut-level appetite. It’s the difference between the desire to grow wealth vs protect it. It’s the opposite of Ability as its irrational & qualitative like Greed & Fear. Is perhaps best measured by the “SWAN Index”. When the markets are crashing can I still Sleep Well At Night?
NEED to take risk is determined by the minimum rate of return required to reach a goal. Need is an aspirational expectation. If you’ve already Won the Game then your need is low. OTOH, if you need 25% returns for each of the next 10 years then its much too high.
JT,
Your approach is very reasoned. Thanks for sharing it with the rest of us.
Cheers!
Chris
opened my eyes to the importance of diversification in my portfolio. The article explained the benefits of spreading risk across different asset classes, and I’ve since made adjustments to ensure a well-diversified retirement portfolio.
Overall, this article served as an excellent guide to help me navigate the complexities of retirement planning. I feel more confident in my decisions and am grateful for the valuable insights it provided. I highly recommend this article to anyone approaching retirement, as it provides essential questions to consider and serves as a solid foundation for building a successful retirement portfolio.
Thanks James.
“How many past bear markets have you been through? How did you behave?”
Well, here’s my bear market history….
I survived the 89 crash and did not sell.
I survived the dot com bubble and did not sell.
I survived the 9/11 attacks and did not sell.
I survived the financial crises of 07-08 and did not sell.
I survived the COVID 19 crash of Feb-March 2020 and did not sell.
And I survived the bear market of 2022 and did not sell.
But I DID continue to purchase through all those “the sky is falling” events while employed and earning income. Retired in Jan 2008 and no longer contributed to portfolio, but started rebalancing anytime my AA drifted by 5 points or more, in either direction. Started retirement with $1.5M, have spent $1.5M in our 15 years of retirement and our portfolio at the end of 2021 was north of $2M.
Awesome JC!
What was your allocation. ?
Tom,
JC has generously shared his story on the blog with lots of details. https://www.caniretireyet.com/case-study-retiring-before-a-stock-market-crash/
Dive in!
JC,
Thanks for sharing. Your track record shows that you clearly have the stomach that matches your approach as well as the discipline to follow it consistently. I encourage everyone to consider their own history and see if you can say the same.
Best,
Chris
Wow, this great post left my head spinning. It’s full of puzzling logic.
‘The lower your burn rate, the less aggressive you need to be with your return assumptions. Simultaneously, a lower burn rate allows you to afford being more aggressive with your investments. The higher your burn rate, the opposite is true.’
If you have a low burn rate you can be more aggressive and potentially earn more returns even though you probably won’t spend them because you have a low burn rate. If you spend more you need to be less aggressive even though you need your returns to be higher which would come from a more aggressive allocation. WHOA!
For me, I’m retiring at 56 with no debt and 40x our burn rate. I could be more aggressive than 50/50 but I just rebalanced here from 60/40. I’m sticking to the adage about stop playing the game when you’ve won. I’ll never say I’ve won, but I think I’ve saved enough to sleep at night and will take less risk even though I may be leaving future returns on the table.