I received a phone call from a family member a few weeks ago. They were calling with a coworker on speaker phone with a question about how he should invest his retirement funds now that he was approaching retirement. His question was, “I am 10 years from retirement and with the stock market as high as it is, should I sell my aggressive stock funds and put the money into conservative bond funds?” On the surface, that sounds like a logical approach, after all everyone has heard that as you approach and begin retirement, you should move more towards bonds. Let’s explore why it’s wrong.
I’ve read a lot of financial books; I mean a lot. It’s embarrassing how many I have on my bookshelf. Most of them talk about how someone early in their life should invest. Maybe it’s self-selected as that is when I read most of my investment books. They all say that when you are in your 20s and even 30s you should invest aggressively with the mindset that your money has 30 or more years to grow until retirement. But here is the catch, retirement doesn’t happen all in one year. Sure, you retire in a given year, but your retirement will last 20 or even 70 years depending on your age when you retire.
The Day you Retire
Let’s say you’ve reached retirement age and you figure that you have 30 more years to enjoy a work optional life. Now notice I didn’t say retirement, but rather a period of your life where you don’t have to work. You could spend your days hiking or sitting on a beach. Or maybe after a year or two of sitting on the beach and watching the bartender make 1,000 tropical drinks, you decide to bartend yourself. Whatever the plan is, you intend for your savings to last 30 years without having the need to work.
On the day that you’ve declared yourself retired, you have 1,000,000 in retirement money and or investments. Do you need all of the 1,000,000 on that day? No, of course not. It needs to last 30 years. At a simplistic 3% withdrawal rate, that would be 30,000 a year. If you only need 30,000 a year to live, then why would you sell out of the other 970,000 invested in stocks now just to have inflation erode your purchasing power?
Let’s get back to all those books on how to save and invest for retirement. At 20 years old, to say that you have a 30-year investment time horizon seems like a no-brainer. Of course, I won’t need that money for 30 or more years. What is less obvious is that statement can be made for a portion of your retirement money at age 60. What?! That doesn’t make any sense, surely, I’ve had one to many of those tropical drinks before writing this.
But it’s true! The last 30,000 of the yearly allotment of the 1,000,000 in your retirement nest egg at age 60 won’t be needed until your 90 if you think that is as long as you will live. To sell all of your aggressive (aka highest returning) investments now and go into bonds would be the same as telling someone at 20 to just simply invest in bonds. Ahh, now that does make sense SW*, maybe you’re not that drunk after all.
If you take the straight-line average of 30 years since it’s equal amount withdrawals then the average is simply 15 years. Thus, at a minimum on the day you retire you should be investing the entire amount with a 15 year time horizon for the more conservative investor. Now keep in mind all of this is assuming your investments don’t grow. If your investments are invested in all stocks and they grow at more than your withdrawal rate, your money can last well over 30 years living a lot of extra room for inflation adjustments and when your healthy lifestyle caused you to shatter some centurion records.
Ultimately I would recommends an aggressive 90% equity investment your entire life. I wish I was smart enough to claim responsibility for such an unconventional recommendation. But it came from someone I truly admire in many ways, Mr. Warren Buffet. By following his approach your money should continue to grow during retirement to give you additional cushion for unexpected events.
* This is the first time I’ve referred to myself as SW on this blog. It’s reminiscent of the Seinfeld episode where Elaine’s boyfriend refers to himself in the third person. “Jimmy’s got a new pair of shoes.”
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