Christine Benz, Morningstar’s director of personal finance, has been writing on the subject of retirement for a very long time.
Whether you’re embarking on retirement in a few years or you have a long way to go, here is some of her wisdom captured over the years that will certainly help you.
- Remember this. Capital preservation is key to building wealth.
Understanding capital preservation is about understanding the risk. Risk is the permanent loss of capital in real terms over the investor's time horizon. You should sit with your financial adviser to calculate the actual exposure to equity, and within equity various market caps. For example, some U.S. experts state that investors would have to delay their retirement by 6 years to recover from a 25% capital loss in their portfolio.
Avoiding large losses remains a key element to building wealth. In other words, capital preservation is the key to building wealth.
Permanent losses are driven by valuation (overpaying for an asset) and deterioration in fundamentals. In case you were unaware, valuation risk is one of the biggest risks that investors face. Avoid overvalued assets and diversify across investments whose cash flows are driven by different factors.
- For the future: It is worthwhile considering annuities.
In the context of annuities in terms of retirement is the issue of longevity or basically outliving your retirement savings. Where annuities actually have a role to play is, obviously, in providing some form of guaranteed income. So, for an investor who incorporates an annuity in the portfolio, it basically gives you some portion of your portfolio that has a stable income and it enables you to be more aggressive with the other part of your portfolio.
- When saving for retirement: Timing is everything.
It is, and unfortunately this is the most common pitfall that we see, where people don’t get serious about retirement planning until they are, say, in their 50s and they want to retire in 10 or 15 years.
The problem is by starting too late, you don’t have that many levers left to fix that plan. So even if you are able to make very generous contributions going forward, even if you make some heroic assumptions about what the market might return over your time horizon to retirement, it may be difficult to make the numbers add up.
The only lever you have at that point is to push retirement further out into the future which, unfortunately, is really the only solution for many folks who start too late. All they can do is keep working for the foreseeable future, because the math of retirement to the date that they’d like to hang it up just doesn’t come together.
- Don’t do this mistake: To make up for time, the allocation gets too aggressive.
Now that your time is constrained, you want to raise as much money as quickly as you can, but it doesn’t always work out that way.
Many people who are starting late for retirement do kind of want to put the pedal to the metal. They want to invest in the asset class with the highest potential return - that tends to be stocks, over long periods of time. But you do need to have a sufficiently long time horizon to have stocks work for your benefit.
Even if you have had a very good experience investing in stocks, and you don't start taking some money off the table as retirement draws close, it could backfire. It often happens that investors haven't steered progressively larger sums to bonds and cash as retirement gets near. That means that their portfolio, as retirement gets close, is way too risky given their time horizon.
I would point out, though, that even people who are closing in on retirement and retirees do need to have stocks as part of their portfolio. They need that return potential.
- As with any portfolio: Diversification is the investors' best friend.
Don’t put all your money in the company stock. We've all seen horror stories where employees have stuffed a lot of their retirement plans into their employer stock.
In a conversation with our David Blanchett, who heads up retirement research for Morningstar Investment Management, I asked him about the optimal level of company stock in an individual's retirement plan. He said zero, from a portfolio optimization standpoint, that you have so much of your own personal wherewithal staked with your employer that you don’t want to have your financial capital staked with that employer as well.
- Plan all the way: Have the money, but don't know what to do with it.
A big retirement pitfall is not having a clearly articulated withdrawal strategy. Once you get close to retirement it is intimidating to start thinking about pulling out of that portfolio that you spent such a long time building. But it's important to have a clearly articulated withdrawal strategy. So think about what is the sustainable withdrawal rate, given my time horizon in retirement, given my asset allocation, as well as how from a logistical standpoint I'll go about withdrawing money from this portfolio.
Will I use a strictly income centric strategy and rely on bonds and dividend paying stocks and other securities that spin off income? Will I potentially tap my highly appreciated winner? Will I use a more total return oriented approach? It's really important to understand what specific strategy you are using for getting money out of that portfolio that you worked so hard to build up.
- The other aspects.
Finally, and perhaps most central for me, is that the money aspect of retirement is inextricably linked with some really crucial life issues: achieving dreams like travel, helping children and other loved ones find their financial footing, and retaining independence for as long as possible. These life goals depend on solid financial resources, of course, but they also intersect with people’s quality of life and sense of purpose.
