What is an appropriate portfolio for someone nearing or in retirement? Unfortunately the simple answers in money management often gloss over important information.
One of the rules of thumb that continues to circulate is to subtract your age from 100 and to put that amount into stocks and the rest into bonds. So if you were 60 years old, you would put 40 percent into stocks and 60 percent into bonds.
There are several issues with this formula:
As life expectancy continues to rise, running out of money becomes a greater risk.
As you age, you break the first rule of investing -- you start to put the preponderance of your eggs in one basket.
It oversimplifies that we only have two choices to invest in and that of the two bonds are safe and stocks are risky.
Looking back it has been very easy and successful for a retirement portfolio to overweight into bonds. For the last 30 years bonds have enjoyed a fixed income plus appreciation spawned by a consistent decrease in interest rates. As interest rates drop, bonds increase in value (the opposite also holds true). In 1982 the 10 year treasury topped out at 14.59 percent and since that point they have continued to drop. It's important that we understand that this trend is not likely to continue in the coming years.
Robert Ketchum, the CEO of the Financial Regulatory Authority, FINRA, said: "it's clear that interest rates have more room to go up than down and that the strategies that were appropriate for many investors a few years ago may no longer
be appropriate today."
Bill Gross, the manager of the world's largest bond fund said "the three-decade bull run in bonds ended 04/29/2013 when the treasury yield hit 1.67 percent.
Brokerage firms led by UBS are talking about re-classifying all-bond account holders from "Conservative" to "Aggressive" Investors.
Despite these warnings Reuters posted that investors allocated $301 billion into U.S.-registered bond funds in 2012 and have added another $121 billion through April of 2013. As rates have gotten so low many investors have sought to increase yields by taking on greater credit risk. In April of this year, investors oversubscribed to buy Rwandan bonds at an annual yield of 6.875 percent. This followed similar purchases from countries such as Bolivia, Zambia and Mongolia.
The continued focus on fixed income is not shocking given investors lost $30 trillion in equity market value during 2008. Those that did not have a process to stay in for the rebound are rightfully twice shy from repeating the experience. Nobody can predict the future, but there are sensible proactive risk management strategies that investors can implement to help limit their exposure to the potential swings of market pullbacks. The Heath Brothers new book, Decisive, says that in making good decisions, "process mattered more than analysis by a factor of six." Having a good process can keep you balanced during times of duress and protect you from overweighting your portfolio towards one risk in an attempt to avoid another.
So what is an appropriate portfolio for someone near or in retirement? The answer, of course, is -- it depends on your circumstances. This is where having a conversation with a certified financial planner, skilled in pairing your goals with your ability to fund them, can help. A professional can offer suggestions on how to restructure a portfolio so it allows you to pursue your goals and minimize unnecessary risk.
Gardner Sherrill, MBA, is the principal of Sherrill Wealth Management, LLC. Reach him at 941-462-2255.