Getting ready for retirement? This new phase you are moving into, the 'decumulation' phase, takes some time, thought and planning to be truly successful. 'Decumulation' is not just about withdrawing money, it's about how and when you will withdraw, and how you can structure your portfolio to last your lifetime. We call that making the peanut butter and jelly last to the end of the sandwich.
Most retirees believe that a safe retirement portfolio should be 100 per cent in bonds, reasoning that fixed income vehicles can generate post-retirement income.
Unfortunately, the focus on bonds confuses certainty with safety. The payment on bonds is certain but it's certainly not safe, especially in terms of purchasing power. Over the long term, even a modest inflation rate can substantially erode your purchasing power in the future. Bonds do not protect your portfolio against inflation.
We don't need income at retirement; we need cash flow, that is, an income stream that keeps pace with inflation. The solution is to design a total return portfolio that focuses on returns and not fixed interest payments. We can diversify more effectively and protect ourselves from inflation and the real risk of outliving our assets.
What to do
- Park the money needed for regular expenses for the next one or two years in cash, money market funds and short-term investments
- Invest a part of the remaining money in stocks to beat inflation and in bonds to minimise volatility
- Ladder bond maturities so that you are not exposed to interest rate risks
One way to do this is to adopt what we call the 'reserve strategy'. You do not need all your funds at once when you retire and will want to ensure that you have money available 10, 15 and 20 years hence. Start by determining how much money you will need to meet expenses in one or two years.
Segregate that amount and put it in another account that will provide you easy, risk-free access to your funds. In our firm, we call this the reserve money - the money you will draw upon in periodic payments, once a month for example, to use for expenses. Your reserve money needs to be parked in a combination of cash, money market funds and short-term investments.
Now let's look at the rest of your portfolio or what we call the 'investment money'. You can invest this money with a long-term time horizon. With a big reserve present to take care of your grocery money needs, you don't have to worry about short-term market volatility. This means you can invest a portion of your portfolio in stocks to protect against inflation and the balance in bonds to minimise the volatility.
In your investment portfolio, you will probably want at least 20-30 per cent equities, preferably blue chip quality, with a broad exposure to various industries. Index funds are a very good way to get this exposure. The balance of your money should be in bonds with laddered maturities, which means that a portion of your bonds will mature each year over the next 5-10 years.
For example, you might have 10 per cent of your bonds maturing each year for the next 10 years. With laddering, not all your funds will be exposed to the risk of current market conditions at the same time. For instance, if interest rates go down, you still have many bonds locked in with higher interest rates. As you rebalance your portfolio (at least once a year), you can refund any depleted funds from your reserve account.
The reserve strategy provides you with a regular paycheque even as your long-term portfolio grows, keeping pace with inflation and ready to serve you when you are 80 and 90 years old. So, as you plan for that post-retirement lifestyle, spend some time planning for that post-retirement nest egg too; the quality of the rest of your life will depend on it.
The author is president of US-based financial planning firm Levitt & Katz, and an expert on retirement planning.
