By Brian Decker
For some retirees, the answer to how much risk they should take in retirement is none. However, depending on your monthly income stream compared to your monthly living expenses, part of your portfolio might need to have more exposure to risk than another person with a different life scenario.
Consider these two cases:
A 65-year-old couple who needs $6,000 per month to live on will have two Social Security checks plus a pension coming in monthly, plus $800,000 saved for retirement. This couple has their monthly living expenses covered without withdrawing money from their nest egg, so they don’t need to take any market risk at all, but instead could place all their money in
- conservative principal-protected investments, if they’d like.
- A single 65-year-old who needs $4,000 per month to live on will have only $2,500 coming in monthly from Social Security, plus $800,000 saved. This person may need to have some market exposure or take some risk with a portion of their nest egg (maybe 25%-30% of their total portfolio) in order to meet their monthly income goals throughout retirement.
Each person’s situation is unique.
Risk in the Retirement Portfolio
How much risk is too much? That’s the question we covered in one of our recent radio shows, How Much Risk Are You Really Taking? Click the link to read the whole transcript, or listen here.
Once you have determined that part of your portfolio should have some risk, you’re tasked with deciding what to invest in. Retirement investing is very challenging because while the stock market offers the highest potential return rate, volatility can derail all your hard work in terms of retirement planning, causing your money to run out.
After three decades of experience in retirement planning, we can rule out some investments that we believe are too risky for retirees.
Five Investments to Avoid in Retirement
- Variable Annuities
Variable annuities offer no downside protection. Any guarantee you are given doesn’t benefit you in your life, you have to die to get the guarantee.
Because of their underlying fees, the returns on variable annuities often don’t even keep up with the S&P. Typically around 8% is taken out of your principal up front to pay the salesperson—usually a banker or broker who is not a fiduciary, and is therefore under no legal obligation to put a client’s best interests first.
Every single year the variable annuity pays more fees out, reducing its value. There are three layers of fees—the salesperson, the insurance company and the mutual fund companies—that typically add up to 5%-7% before you ever make a dime.
There is a saying in the business that variable annuities aren’t bought, they’re sold. Meaning that if you knew all of the expenses involved with them, you would never buy them.
- Bond Funds
Bonds and bond funds are often used synonymously by bankers and brokers, they’re supposed to be the “safe money” portion of your portfolio. (Safe money by definition implies that the value won’t go down.) The “rule of 100” states that if you’re 65 years old, you should have 65% of your portfolio in bonds or bond funds, and increase the percentage by your age every year.
Right now, interest rates are at historic lows. Last May the 10-year treasury was at 1.4%, and it’s around 2.3% now. Why would you put the majority of your retirement money in assets that are paying next to nothing?
But an even greater problem when it comes to bond funds is interest rate risk. Remember, only when interest rates go down do bond funds make money. When interest rates go up, the value of bond funds goes down—like in 1999, when the treasury rose from 4% to 6%. The average bond fund that year lost around 17%!
With interest rates at rock-bottom lows, isn’t it common sense to think they will be going up and not down in the future? Saying bond funds are “safe” for retirees amounts to financial malpractice, in our opinion.
- Oil and Gas Partnerships
Often oil and gas partnerships are purchased by retirees for the dividends they pay. But comparing to see which company is paying the highest dividend is only part of the equation. What’s often missed is analyzing the underlying EBITDA (earnings before interest, tax, depreciation and amortization) and cash flow to spot problems before they happen—before a company might suddenly stop paying out dividends because they’ve been borrowing to pay them in the first place.
With investments known as Master Limited Partnerships or LPs, you become a “partner” with a whole lot of other investors to pursue one limited endeavor, like wildcatting or exploring for oil or gas. They aren’t limited to the oil and gas industry. The biggest problem is that the terms of partnership are such that salaries and compensation are set aside first before any net profits are paid back to investors.
There’s really no type of industry or sector not subject to market cycles (growth, maturation and decline) or drops, which puts your retirement money at risk. Consider technology and what happened with the tech bubble, or utilities and what the creation of the cell phone did to AT&T.
- Stock Options and Futures
Stock options are a leveraged way to invest in a company utilizing “puts” and “calls.” Trouble is, they are essentially gambling. It’s not investing–it’s speculation. You might make money once or twice, but then you’ll lose all that and more later.
And futures are to commodities what options are to stocks. Basically, we think it’s best to avoid them.
- Foreign Exchange
Foreign exchange (sometimes called forex or FX) is the global trading of all the different world currencies. There is a lot of volatility with these sorts of investments, and they are not recommended for anyone’s retirement portfolio at this point in time.
Original source material courtesy of Decker Retirement Planning, Inc.