Helping investors prepare for the fragile decade, (the five years prior and five years after retirement), is a central focus for our firm. While people are living longer for sure, in many cases, their financial health is struggling to keep up.
Planning and preparing are THE MOST IMPORTANT aspects for investors entering this dangerous timeframe but often ignored, sometimes, with lifestyle altering consequences. I read not long ago that most serious mountain climbing accidents happen on the way UP THE MOUNTAIN, not on the way down. If you ignore the planning and preparation stages, the outcome may be perilous.
We are Living Longer
Technological and scientific advances combined have boosted life expectancies in America and most other developed countries over the past half century. These increases have slowed, but still a healthy, 65-year-old couple today can expect that one will still be alive at age 92. With this as a backdrop, here’s a list of potential key problems and how you can prepare.
1. Preparing For Stock Market Variability– This tops the list because the idea of the stock market acting like anything other than a bottle rocket streaming upwards toward the sky is scary to all investors, but particularly for those in the fragile decade.
Prices of stocks change every minute based on millions of market participants worldwide, their individual expectations, and all available information.
Investors should fully expect prices to change and it should not be a surprise. On average, the U.S. stock market declines at some point during the year by almost 14%, yet ends up positive about 75% of the calendar years. Roughly every five years or so, the market declines by 30% or more. Despite all that, over the long term, stock market increases have significantly outpaced underlying inflation. That final point is the reason for investing in “risky” assets in the first place.
2. Preparing For Longevity– It’s difficult for investors with retirement on the horizon to understand how different their risk orientation might be relative to previous generations. The biggest breakout in longevity increases started less than 50 years ago and has forever changed how retirees assess their resources. Changing the status quo is incredibly difficult but the sheer mathematical shape of planning for potentially decades of uncertainty demands a different approach.
In times past, investors retired and assumed smaller levels of ongoing investment risk because of two important factors: shorter life expectancies; and a generally better level of financial resources relative to income needs.
One of my favorite phrases is “days or decades.” That is, only God knows how long we may be here and it could be a few short days or decades into the future. Because this is both unknown and unknowable, we have to plan and prepare for decades.
3. Preparing For Taxes– Income tax laws change with great frequency and Investors in the fragile decade are particularly sensitive to these changes. Our standard mantra to clients still working is to invest as much as they can in both tax-deferred AND taxable investment accounts. Having a mix of accounts and a mix of different asset holdings increases flexibility in tax planning terms. This flexibility is largely owed to the tax rate distinction between long-term capital gains (currently taxed at 15% for most taxpayers) and ordinary income tax rates (up to 37%). If your only source of retirement income is a 401(k) or IRA, every withdrawal is taxed at the higher ordinary income tax rates. Our one-page overview, Money is Money, discusses our approach to building income in retirement.
4. Preparing For Living Cost Increases– I saved the most important for last. The primary objective for investors in retirement is not to just maintain income but to actually increase income over time because of inevitable living cost increases. Inflation has averaged about 2.9% per year for the past 90 years. For someone born in 1960, the calculated rate of inflation during their lifetime has been even higher at 3.7% per year.
Your Source for Increasing Income in Retirement
The conundrum facing investors in the fragile decade is exactly how to overcome this obstacle once they fully retire. The most reliable source for increasing income in retirement is the stock market. Yep, not gold, commodities, private equity, hedge funds, or real estate. None of these assets have reliably been able to generate returns equal to stocks. From 1926-2018, the S&P 500 Index has produced a return of 10% per year. Adjusted for inflation, this works out to a real return of 6.9% per year.
The Impact of Inflation
Since inflation is essentially guaranteed to continue, most retired investors will need to maintain significant allocations in stocks for the remainder of their lives. There simply is no other way. Are stocks risky? As described earlier, you should expect prices to vary every day and for temporary declines to continue as they have previously. We should also expect the permanent uptrend to persist. In my opinion, the more substantive risk is NOT investing in stocks. Once you have “folded your tent” by avoiding stocks, you have assured yourself and your family of an ever-decreasing standard of living as inflation chips away year after year.
The most critical objective for investors in the fragile decade is to set a trajectory for increasing income from their investments. To accomplish that, breaking away from status quo might be required. Start there. Ready for a real conversation?