5 things conservative investors must remember

Oct 02, 2021

One of the most illuminating portfolio makeover that I’ve had the chance to work on over the past few years featured a retiree employing a conservative strategy.

At age 70 and divorced, Ted was savouring life in a warm climate, spending time with his significant other, enjoying his photography (and making a little bit of money on it, too), and relishing his close bond with his adult daughter.

He was extremely frugal--purchasing a small SUV that he expected to keep for many years was a rare splurge. He was content to make do on Social Security and extremely modest portfolio withdrawals of less than 2%. His portfolio wasn’t huge; generating $9,000 annual cash flow in 2018, and even less post taxes.

Ted’s portfolio had about 70% of assets in cash and bonds. So I nudged up his equity weighting to 50% of assets from 30% previously.

My reasoning:

  • I had some concerns about the effect of inflation on his purchasing power, especially because he noted that his healthcare expenses were beginning to flare up.
  • With a spending rate as low as Ted’s, he absolutely could afford to take more equity risk; even if his equity holdings encountered a sustained bear market, there was little to no chance he’d need to sell them in a trough.
  • Switching into a more-aggressive portfolio mix would probably enlarge his eventual balance, which he could use for travel or pass on to his daughter.

But in hindsight, I wondered if my suggested increase of stocks was more reflexive than it was necessary. Given Ted’s very modest spending rate, he could afford to maintain a more conservative asset mix that provided him with more peace of mind than he’d be able to have with a more stock-heavy portfolio. His portfolio was enough.

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Ted’s approach reminds me of the saying I most closely associate with asset-allocation guru Bill Bernstein: “If you’ve won the game, quit playing.”

The basic idea is that if you’ve built your portfolio up to a point that it meets your goals--as did Ted--you don’t need to keep gunning for additional returns. Instead, you can switch your focus to extracting your cash flows from a more conservatively positioned portfolio that provides you with peace of mind.

Ted’s case is also an illustration that you don’t need to have several million dollars to shift into the “enough/peace of mind” camp. People of more-modest means can get there, too. The key is that the portfolio spending rate must be low enough to make it work, and the portfolio should be positioned to support that spending as well as to accommodate inflation and short-term spending shocks.

But here is what Ted, and those like him, must remember.

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#1. “Safe” assets with low return potential pose challenges

A key consideration for investors attracted to a less-volatile portfolio that features lower equity exposure is that the return potential of fixed-income assets has dropped markedly over the past several decades. That has implications for safe withdrawal rates as well as growth of the portfolio.

Retirees who wish to maintain very conservative portfolios also need to be similarly conservative about their withdrawal rates. The trouble is that many retirees won’t find that to be a liveable income stream.

Maintaining a very conservative portfolio has risks of its own. The portfolio may not grow enough to support the planned spending rate, or that spending could increase due to inflation or a lifestyle shock, such as long-term care expenses later in life. If you’re inclined to de-risk your portfolio for retirement because your spending rate seems low relative to your portfolio size, be sure to consider the following as part of your calculus.

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#2. Inflation

Even if you have a disciplined spending plan in place for your retirement, it’s worth bearing in mind that in-retirement spending isn’t 100% within your control. Anyone who has gone to the grocery store or filled up their gas tank is aware of the risk of higher prices. Then there are healthcare costs that are also inflationary.

Inflation is certainly a risk factor for everyone, even retirees who aim to hold their spending at very modest levels.

Higher inflation has the potential to drive your overall spending--and in turn your withdrawal rate--higher than you intended, even if consumption remains the same.

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#3. Spending patterns

It’s worth considering what you spend money on--and in turn your total spending rate--might change over your retirement life cycle, too. Research points to spending tapering down in the middle years of retirement, then flaring up toward the end, largely due to uninsured healthcare costs.

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#4. Take a holistic view

Consider all of your income sources together—return from portfolio, rent from property, allowance from children, pension, and annuities. Or even earning some income from, say, giving tuitions. It may be possible to create a baseline of retirement cash flows through non-portfolio sources to cover very basic living expenses. That takes pressure off the portfolio and portfolio withdrawals, which in turn can contribute to peace of mind. 

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#5. Talk to a professional 

There are so many moving parts in creating a retirement plan; changes in one part of the plan have repercussions in another. For that reason, it's valuable to get a professional opinion on any asset allocation or withdrawal setup you're contemplating, to understand and troubleshoot any unintended consequences.

(This article has been adapted for an Indian audience)

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