By: Coryanne Hicks, Business Insider featuring Craig Eissler, CFP®, CIMA®, AIF®, PPC®, Wealth Advisor at Halbert Hargrove
Retirement marks a pivotal shift not just for your lifestyle, but also your investment portfolio. Your focus turns from accumulating assets and growing your wealth to how you’re going to live off of those savings, potentially for decades to come.
“Minimizing the likelihood that you run out of money in retirement or the likelihood that you must drastically change your lifestyle or goals throughout retirement requires careful management of your post-retirement income,” says Emily Harper, vice president at partner at Monument Wealth Management. “Instead of having a fixed paycheck that covers your needs while you are working, retirement introduces the challenge of relying on multiple sources of income – sources that are often variable.”
How to approach your post-retirement investing
As a retiree, the two main risks you face are that your portfolio loses value (market risk), and that you run out of money before you die (longevity risk).Before retirement, you have more time to withstand the ups and downs in the market, so you can lean more heavily on investments like stocks that, while volatile in the near-term, historically have had superior long-term returns.
“(Pre-retirees) have the ability to use a volatile market to their advantage and continue to add to their portfolio even in down markets,” then ride the market back up, says Craig Eissler, a professional plan consultant and wealth advisor at Halbert Hargrove. “Someone in retirement not earning income does not have those same luxuries.”
Retirees typically shift to safer investments such as bonds that are less likely to experience sharp or sudden declines. But this only addresses the market risk.
With retirement potentially lasting for upward of 30 years, retirees still need some growth-oriented investments to keep up with inflation and the rising cost of retirement living to make sure they don’t run out of money. This requires a careful balance of risk, income, and preservation of capital.
“Investing post-retirement should focus on a lower ability to bear risk, should aim to strike a balance between generating enough growth to get retirees to the finish line, while avoiding sharp drawdowns, which could negatively impact their standard of living,” says Mel J.Casey, senior portfolio manager at FBB Capital Partners.
Some of the key considerations that go into developing a post-retirement investing plan include:
- Cash flow: “Know how you will be spending your money and most importantly the why behind each expense,” says Brad L. Cast, wealth manager and partner at Merit Financial Advisors. He recommends making a budget, reviewing it often, and adjusting as necessary. Be sure to factor in inflation and the rising cost of health care.
- Flexibility: It’s impossible to predict your retirement spending needs with 100% certainty. A post-retirement investing plan needs to account for this variability by allowing you to be flexible in the size and timing of your withdrawals, Harper says. This will also let you maintain some control over your post-retirement tax bill.
- Liquidity: You need a portfolio with sufficient liquidity so that you can access the cash you need when you need it. You can do this through fixed-income investments or by periodically raising cash by selling appreciated equity investments, Casey says.
- Volatility management: Portfolio volatility is a bigger concern when investing in retirement. “Taking distributions when markets are down can force us to liquidate investments at inopportune prices,” Casey says. “If the market weakness persists for some time, this can lead to a vicious cycle and negatively impact the long-term plan.”
Cast suggests starting to build your investment plan by determining your post-retirement expenses. Once you’ve established that, determine what other sources of income you’ll have, such as Social Security. The difference between your expenses and the amount coming in from other sources will tell you how much income you need from your investments in retirement.
Based on your income needs, you might focus your retirement investing on yield-producing investments in the fixed-income market, dividend-producing investments in the equity or alternative market, or income-producing investments in the insurance market, Cast says.
Note: Your estimated expenses in retirement minus your non- investment income equals how much income you need from your retirement portfolio.
5 investment options for retirees
These are some of the most common investment options to extend your savings and manage risk in retirement:
1. Certificates of deposit
A certificate of deposit (CD) is a type of savings account where you agree to lock up your money for a period of time in exchange for a fixed interest payment. When you redeem your CD, the bank gives you your original deposit back plus the interest you’ve earned. They’re considered one of the safest investment options since they are not subject to market fluctuations. CDs purchased through a FDIC insured bank are also insured up to $250,000, so even if the issuing bank experiences financial trouble, you can get your deposit back.
CDs can be good for retirees due to their stable stream of income and low risk. The downside is that the rates offered are often low and may not keep up with inflation. So it’s best to pair them with more growth-oriented options to help combat longevity risk.
Quick tip: Brokerages may offer CDs, some of which may offer a higher rate than bank CDs, but brokers are not licensed or certified by a state or federal agency. Be sure to do careful due diligence to ensure any deposit broker is reputable before purchasing a CD.
Annuities have developed a bad reputation as being fee-heavy and full of fine print. But their ability to provide a guaranteed source of lifetime income in retirement should not be overlooked. The key is to determine what type of annuity will best meet your retirement needs.
Annuities fall into two buckets: immediate versus deferred, and fixed versus variable. Immediate annuities begin paying income right away, while deferred annuities start paying income at a future date chosen by the owner. Within these two categories, you also have fixed and variable rate annuities. Fixed annuities pay a guaranteed minimum rate of return through a fixed series of payments. Variable annuities tie their return to the performance of certain underlying investments, usually mutual funds.
“While illiquid investments and products like annuities may have a place in your portfolio, they should not be the entirety,” Harper says. Like CDs, annuities cannot provide the growth a retirement portfolio needs to keep up with inflation.
Bonds are common fixtures in retirement portfolios thanks to their reliable income. “While it’s true that yields have been anemic for quite some time, the fact remains that bonds issued by high-quality companies and held to their maturity date will provide needed, regular income while reducing overall portfolio risk,” Casey says.
A common retirement investing strategy is to create a bond ladder where you hold bonds of different maturities. As old bonds mature and the principal is repaid, you can use the proceeds to buy new longer-term bonds to create a steady stream of income and mitigate the risk of interest-rate changes.
4. High-quality dividend stocks
With retirement potentially lasting 30 or more years, it’s important to have a source of growth in your portfolio. Stocks can provide this growth and a hedge against inflation. But not just any stock belongs in a retirement portfolio.
“When allocating to equities within a retiree’s account, it is important to focus on high quality, mature companies with competitive positions within their industries, reasonable valuations and growing dividends,” Casey says. “The highest valuation companies in the market tend to be those that suffer the most in a market downturn. And with a shorter time horizon and regular liquidity needs, the post-retirement investor may have less flexibility to ride out these difficult periods.”
Instead, look for quality companies with a history of paying regular and growing dividends, which can serve as a source of income regardless of the stock’s current valuation. Be aware that the dividends are not guaranteed, however. A company can stop paying its dividend or change the amount of the dividend at any time. Pair dividend-paying stocks with more reliable income sources, such as bonds and annuities.
5. Liquid alternative investments
It’s important to manage volatility in a post-retirement portfolio, which means you need to have investments that react differently to market events. Stocks and bonds are known for typically moving inversely to one another. But an even better hedge can be liquid alternative investments. They include funds involved with direct lending, private real estate, public and private credit markets, as well as reinsurance.
“These assets have very little correlation to both stocks and bonds, and adding low-correlation assets to a portfolio further reduces the risk without diminishing potential returns,” Eissler says.
Incorporating alternative investments is particularly important when the expectation is for a low-return environment going forward. “Having some bond alternatives in a post-retirement portfolio can help improve long-term outcomes by producing income in a different way than stocks and bonds,” Eissler says.
Quick tip: Use a combination of income and growth investments to help your portfolio keep up with inflation while also providing current income.
Putting it all together
Investing doesn’t end with retirement. While almost all retirees face the same challenge of mitigating market and longevity risk, every retirement is different. The investment options laid out in this article can all be a part of a solid retirement investment plan, but the ways and extent to which they’re used will vary from person to person.
“Do not break the boundaries of your risk profile to chase excessive yield though,” Cast says. “Focus on investments that combine to produce the income you need, not necessarily the income you want.”