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Pre-retirement – Shifting Gears – The Financial Preserve from Lonier Financial Advisory LLC
Conscientious Financial Planning and Retirement Income Management | 201-741-9528
from Lonier Financial Advisory LLC, Osprey, FL

Pre-retirement – Shifting Gears

Pre-retirement – Shifting Gears

In the 5-10 years before retirement you begin to shift gears. If you’ve been following a lifetime financial plan, by this time you should have a sizeable and growing investment account that’s spread across risky and less-risky assets in a way that is well suited to your goals and resources. Your investments are growing at a rate consistent with your goals with no more risk than you can reasonably afford.

Once you are in retirement and have changed from saving (accumulation) to living from the income of your savings (distribution), you will likely need to change your investment strategy to one more suitable for retirement income generation. These pre-retirement years are when you begin to make these changes.

If you haven’t been following a plan or have not been as successful saving and investing as you would like, then this is an important time to get organized, take stock, and get it control. Regardless, you are entering what for many is the most financially conservative period of their lives. This is the time to consolidate and set the stage for what will hopefully be many satisfying and productive ‘non-working’ years—and not the time to pile on market risk trying to make up for missed opportunity. Saving more, yes; investing foolishly, no!

Retirement income planning is not well understood by many financial planners and advisors, and not just by those who sell securities. During the long Boomer years of accumulation, it took a back seat to a focus on savings and investment strategies. With the Baby Boom generation now entering retirement, the focus is beginning to change. Retirement income management is a relatively new field—two new certifications for retirement financial management were introduced in just the past year.

Both the size of the Boomer retirement wave and increasing longevity underline the growing need for informed, conscientious retirement planning and advice. This advice can differ significantly from the usual savings and investment guidance about balancing stocks and bonds, and risk and return—those are accumulation strategies, not sustainable income distribution strategies.

When Social Security began during the Roosevelt era, life expectancy was just a few years beyond the date retirement benefits began. Even a generation ago, a twenty-year retirement was exceptional. The cost of the healthcare that has so improved longevity had not yet skyrocketed. While inflation was higher then, so were real rates of return in relatively safe investments like bonds. The pressures that bear on a retirement income plan today did not yet exist. But that was yesterday.

Today, unless you have serious health concerns, you should plan for a thirty-year ‘retirement career’ in which your income will come from Social Security, any pensions you may have, and from your own savings. This can be a stunning realization—thirty years—almost the equivalent of another whole working lifetime. Without a paycheck.

The possibility of outliving your savings (longevity risk) can create a great deal of anxiety for pre- and recent retirees. Though you may at times be gripped by the concern that you haven’t saved enough and need to make up for lost time, the worst strategy is to amp up your investment portfolio, and swing for the fences trying to hit an Apple-sized home run. Quite the contrary, as you enter this period, you should begin to de-risk.

Depending on your situation, there are a number of sound strategies to make the most of your resources for your non-working years.

The most secure approach for everyone is to have a solid floor of income that covers the necessary expenses of your lifestyle. Typically this includes Social Security, pension benefits, and income investments.
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The lower this floor is relative to your expected annual expenses, the less you should be invested in the markets. You simply can’t afford to lose any savings in a market downturn if you have barely enough to cover your living expenses. In this case, you may need to annuitize your savings, both for the additional income immediate annuities offer and for the guarantee that you won’t outlive the annuitized income stream.

You may also need to continue working beyond the date you had hoped to retire to meet expenses, save additional money for the rest of your non-working years, and push-off the need to use your savings just yet. The longer you can wait to claim Social Security, the more it will pay you. And the longer you can wait to annuitize, the bigger the monthly annuity check.

If you have enough resources to fund your living expenses, and even some upside, then you should use this pre-retirement period to start shifting your investments out of risky assets. You can begin by tilting your quarterly portfolio rebalancing away from stocks. In essence, you are changing your stock/bond allocation over a period of years, say from 60% stocks, 40% bonds to 40/60 or 30/70, depending on your circumstances.

We’ll leave the makeup of the bond component of this ‘shifting gears’ portfolio—cash, Treasuries/TIPs, corporate, preferreds, and high yield—for a later post. Suffice to say, as the increasingly critical component of your retirement plan, the makeup of the bond allocation sleeves is important. And challenging in the current low-interest rate, inflation-sensitive environment.

If you are fortunate to have significant resources above those needed to fund a solid income floor with a safe bond allocation atop Social Security, then you should consider building a more typical balanced portfolio with those additional funds above the floor to stay ahead of inflation and capture upside for discretionary spending during your non-working years.

Like the shifting gears portfolio above, this ‘upside portfolio’ should start with a conservative allocation during retirement planning and early retirement years when you are most exposed to downside risk. Since in this case your risk capacity is higher relative to your expenses and income floor, you can mix in some higher yield but riskier assets such as MLPs and dividend stocks. As you get older and your needs and wants seem increasingly well covered, you can shift the portfolio towards more moderate overall risk, improving potential return to support your legacy goals.

Paraphrasing Mark Twain, pre-retirement is one of the particularly dangerous times to suffer a sizeable drawdown in your investment account. (*The other dangerous times, are middle age, early career, and retirement!) Loading up on aggressive growth funds or trying to pick hot stocks to make up for a savings shortfall adds more risk to your investments, just when you need less. The increased volatility of growth funds or stocks puts your savings in greater jeopardy just when you need it to start generating income and there is little time left for recovery (sequence of returns risk).

There are a number of important things on your personal balance sheet that may change significantly during this period—where you live, changing or leaving your job, your housing, mortgage, tax status, income level, possible post-retirement employment, and so on. It makes sense to de-risk your investment strategy during a period of this kind of change.

Once you’ve sorted out some of the important lifestyle questions about housing, living expenses, healthcare, and income-generation in post retirement, there will be plenty of time to shift some of your portfolio back into a moderate growth strategy that is suited to your situation.

Next time, income distribution strategies—living in retirement with income flooring, systematic withdrawal, or the bucket strategy.


*Mark Twain: “October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.”

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