Money Clinic: Luck of the Draw

When it comes to planning for a comfortable retirement, there is no question that a certain amount of luck is involved in the process. You could build a solid nest egg but still face terrible draw-down issues if you decide to retire right before or during a long bear market. On the other hand, if you are fortunate enough to retire at the beginning of a strong bull market, your savings could easily last for decades.

Unfortunately, nobody can predict the future or what the markets will look like on the day you decide to retire. Yet, while it may seem like an impossible task, you can put the odds in your favor by following a few simple techniques.

The first way to set yourself up for success is to build your retirement portfolio by saving money early and often. The longer you wait to save for retirement, the more you need to plow away. For example, if your work for a company that offers matching retirement funds, you must contribute at least the same percentage they contribute to maximize your savings. If you are older, then you should contribute more but don’t totally sacrifice your current lifestyle either!

Yes, it takes money to make money, but it isn’t only about saving money. You have to build multiple sources of retirement income because you have no idea what the environment will look like on the day you retire. You will also need to build a healthy savings account as you approach retirement so don’t wait until the year before you want to exit the work force to construct it.

Therefore, the next way to help ensure your future financial success is to properly diversify your assets by using multiple financial products to build your retirement portfolio and try to avoid major losses along the way. There is no one perfect financial product. Don’t let the financial charlatans ever sell you that myth.

Many people whose sole source of retirement funds was stashed in 401k’s had to postpone retirement after watching their retirement accounts get destroyed during big market corrections. By using strict investment rules to curb losses and asset allocation strategies to diversify away some of the risk, you can increase your chances for success in a big way.

The little things matter too. Investing more money during market corrections, avoiding panic-based selling decisions and rebalancing your accounts can make a big difference in the amount of money you have available for retirement. Nobody is perfect, so knowing when to cut your losses is very important too. Also, avoiding certain stocks in periods when the market decides it isn’t going to pay a high premium for expensive holdings is a way to prevent big blowouts in your portfolio.

Did you know that a big part of a move in a stock price is based on the sector that it’s in? Due to the plethora of exchange-traded funds and mutual funds prevalent in the market and the pressure for portfolio managers to perform, they are committed to cyclical trends/sector-based thinking to help capture returns and they are big buyers and sellers that help set prices. Therefore, you need to factor this into your selection and timing process. You want to be out in front of them – not behind!

Finally, you must know how to withdraw money from your retirement accounts. It is always best to have at least one-years’ worth of expenses in a savings account besides the amount you have reserved for emergencies, short-term expenditures and other big-ticket items.

You should also set up multiple buckets of money that can provide income no matter what happens in the markets. It certainly doesn’t hurt to begin this process years before you plan to retire. Some people use real estate investments to throw-off income, others use annuities with riders that pay lifetime income. Cash value life insurance has been a proven stalwart choice. It’s also never wrong to own strong dividend-paying stocks to provide stable income and potential growth.

Depending on your income tax bracket, it could make sense to have a solid portfolio of municipal bonds to provide tax-free income. In a retirement portfolio, a solid stable of bonds also serves as second-tier emergency fund in case you encounter several years of consecutive market declines.

Of course, it still pays to own stocks over the long-term because you need to keep pace with inflation (including potentially higher health care costs) over a potential thirty-year retirement, so having exposure in 50% of that asset class is not unreasonable. However, you still need to adhere to strict rules for protecting any downside risk. You might think this is common sense, but I’ve seen seventy-year-olds maintaining an 80/20 equity/bond ratio that swear they have a competent financial advisor! It is important to construct an allocation that you can stick with, so if you are asked to complete a risk profile questionnaire, make sure to assume the worst case scenario because when the market corrects, you are likely to bail at the wrong time.

Moreover, the investment process doesn’t end on the day you retire. It is a lifelong process that pits the will of the markets against your will or the will of your financial advisor. You will undoubtedly have to adjust your asset allocations to reflect changes in the market environment. For example, you may have to liquidate some bonds to fill up your savings in a prolonged bear market or you might take some profits from investment gains to have money available for the next correction.

Sometimes, you may need some help along the way. There are times when you can increase your chances of success by working with a top-notch consultant who can help you build, maintain, and protect your different buckets of money.

However, be careful who work with. It is a grueling game and you don’t need somebody who is just a product-pusher coagulating a hodgepodge of financial products that don’t help you play the game any better. The truth is that the financial services industry has many caring people of the highest integrity who truly want to do what’s in the best interest of their clients. Unfortunately, many are operating in a “closed circuit” environment in which the tools at their disposal are “pre-engineered” to be in the best interests of the “house.” The system is designed to reward these salespeople (often disguised with impressive designations after their names) for selling, not providing “conflict-free” advice. Always avoid purchasing any financial product from anyone who makes recommendations without considering your complete financial picture.

It is imperative that you demand the best from yourself and anybody you work with. You can improve your game by holding yourself and anybody that helps you accountable for your results. You also need to exhibit strict discipline in order to stay in the game and sometimes that is what a great advisor can best help with.

Furthermore, always follow the rule: the purpose of the money dictates where you should put it. This is how you can often weed out the financial hacks that try to sell you products that don’t meet your objectives.

When it comes to the luck of the draw, you CAN put the odds in your favor…if you at least know how to play the game.

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