Wednesday, February 27, 2013

When We Near or Enter Our Retirement Years, Our Investing Approach Needs to Be Different Than When We're Younger

Owning stocks for the long haul is a winning investment approach. The historical record clearly demonstrates that over time stocks always outperform all other forms of investing by a wide margin.

It's also clear that market timing is a fool's game, albeit one played by the pros and brokers in an effort to get individuals to trade frequently and entrust the management of their money to them. In other words, investment professionals and brokers earn their livings by taking a "cut" of what individuals otherwise would keep to themselves via a  DIY approach.

Simply stated, a buy-and-old approach doesn't maximize the earnings of pros and brokers. As a result, they often encourage individuals to trade frequently. That's good for the pros and bad for the individuals.

In any case, when we get older, even the recommended "all-in-stocks" individual investing game changes. As we near or enter retirement, it's wise to consider taking some money out of the market and placing it in a more "protected" or diversified asset portfolio, meaning that the oldster owns fewer stocks as a percentage of the whole.

For oldsters cash, at least in part, becomes king, if only because markets fluctuate and a downdraft can hit at any time and for any number of reasons. And when it does hit, it's always a surprise.

Thus, oldsters are both required and able to have a shorter investing time horizon than younger folks. It's a birthday related thing.

Retirement investing is different covers the bases well for those nearing and also for those already in oldster status:

"The Dow Jones Industrial Average recently broke 14,000 and the Standard & Poor’s 500 Index plowed through 1,500 — happy days are here again! . . .

Yup, it's time to get invested again. Or is it?

Maybe not. Maybe the time to get invested was months ago, when values were much more attractive and stocks may have had less downside risk. This conclusion would be especially apt during retirement, when managing downside risk is of paramount importance.

Retirement investing is different

But investing is investing, right? No, not really. Not when you're retired or within five to 10 years of retirement.

When you're young, you've got time on your side. You can handle a bear market decline of 50%; eventually, the market will bounce back for you. Besides, you don't need to pull funds from your portfolio to pay the rent and medical bills. You can just sit in stocks and let it ride.

Retirement investing is an entirely different animal. A bear market can wreck your retirement. Think of it: those 50% declines in stocks we've seen twice in the past decade require a 100% return just to make it back to even. But if you're pulling out capital to fund your retirement, you're multiplying your losses and you're probably going to need even more than a 100% return to get back on track.

That's a pretty tall order. Portfolio losses and regular withdrawals are like oil on fire: they can lead to a downward spiral in your net worth and, worse yet, a diminished retirement lifestyle. The math can be diabolical, and so can your loss of sleep.

Disciplined investing is mission critical

When you're retired or planning to retire in the next five to 10 years, it's time to change your approach to investing. . . . From this day forward, investing is serious business; you're playing for keeps. One bad mishap can have lifelong repercussions.

Discipline is now mission critical. . . . When you're retired, the winner is no longer the genius who discovered the next Google — it's the investor who avoids the brunt of bear markets and generates consistent returns year in and year out. Yes, the game does change.

Focus on value

To be a winner in retirement investing, focus on value. Determine an asset allocation of equities and bonds that fits your objectives and risk tolerance. Rebalance around the asset allocation based on extremes in value. Be a contrarian. As Warren Buffett says, "Be greedy when others are fearful; and fearful when others are greedy." . . .

Investing is not an exact science. You don't have to pick the tops and bottoms. As a retiree, you just need to maintain a reasonable asset allocation, generate the returns you need, and avoid the big losses as much as possible. Of course, that's easier said than done. Value can be assessed in many ways, and one investor's bargain may be another's sell. That's when it pays to be a contrarian. Extremes in market emotion can offer clues about value: high optimism suggests overvaluation, while deep panics are usually associated with undervaluation.

Think like a business buyer

. . . The U.S. has solid fundamentals and a good future. But sometimes it faces difficult times. Two recent examples are in 2002 and 2008, when stocks plunged and valuations were extremely low — those were good times to buy. Now think back to 1999 and 2007, when stocks were soaring, investors were euphoric and valuations were high — those were opportune times to rebalance, take some profits and perhaps trim your equity holdings. . . .

At a time like today, when your friends are boasting about their gains and stock prices are at five-year highs, maybe it's time to exercise some discipline. Rebalance your portfolio. Take some profits off the table. Keep a reasonable allocation to stocks, of course, but do a reality check on whether your equity exposure is in line with your risk tolerance. If not, maybe you should reduce your downside risk.

Sure, the market may go higher, perhaps much higher. . . . But retirement isn't a time for heroics; it's a time for discipline. Eventually, valuations will return to more reasonable levels and your discipline will be rewarded.

In the meantime, you'll keep on track with your financial plan and sleep a lot better."

Summing Up

Returns on stock ownership and time are closely correlated. In the short term, anything can happen.

The longer the period of ownership, however, the greater the assurance of solid returns.

That said, stock prices are chock full of near term volatility as well. They go up and they go down, and without any forewarning. The definition of a surprise is that it's not foreseeable, and surprises are what cause unforeseen big market moves.

So as we get older, we need become more disciplined about buying and selling stocks.

As you may know, my own view is that we're likely to see the Dow hit 30,000 within the next ten to fifteen years.

In the interim, we're highly likely to receive cash dividends on those stocks which will pay more than interest on bonds will pay and which will at least offset the effects of inflation.

But if we're going to need to cash out, in whole or part, during the next several years, it's always a good idea to consider taking some 'winnings' off the table periodically.

Why not?

Thanks. Bob.

1 comment:

  1. It makes sense to not invest the same as an older person that as a younger person did. Hopefully, by that time, you know what you are doing too! Since there are so many options, you need to learn about the variety at I hope to be able to retire well when I get there, so I will have to keep all this in mind too.