Editor’s note: Ilene Slatko is a long-time columnist for Rethinking65. Read more of her articles here.
Ilene Slatko
The standard wisdom is to move our investments out of growth and into safety as we age. Many target-date funds are designed to do just that, moving assets to close to 80% in government bonds as we approach distribution age.
But, what if the standard wisdom is wrong?
What happens when clients retire at 62 and begin to take retirement income and then live for another 25 years? Right now, as we grapple with higher-than-average inflation, the tug on purchasing power has become evident.
Eighty-one. This is the magic number for women. Seventy-eight is the magic number for men. These numbers represent the average life expectancy now in the U.S. Regardless of our life expectancy, a 2024 MassMutual survey reports that the median age at retirement is 62.
With 16 to 19 years of living on retirement and other investment income, including Social Security, how many of our clients risk outliving their purchasing power? More than we might think.
Fear Is Often in the Driver’s Seat
The rationale behind the standard-wisdom shift to more conservative investments is two-fold. First is the idea that our risk tolerance changes with age — that we become more anxious about market volatility and potential losses. Second is the need to preserve capital: A large drop in the market concurrent with retirement can derail income production, just as we need it most.
But when we ask clients how they think about risk in their portfolio, we get a variety of answers.
Perhaps, if your clients are familiar with Modern Portfolio Theory, they might calculate the various returns to ascertain whether their potential rewards are compatible with the level of risk they’re comfortable taking in their portfolio
More likely, however, the average investor repeats the adage “high risk, high reward” without being able to quantify or understand what results are acceptable. And some investors simply cringe in fear because risk equals loss, in their experience or in their mind.
Determining Reasonable Benchmarks
One thing missing in the examples above is a tangible benchmark. Part of what I do is to help people understand for themselves, what a reasonable benchmark should be. In all my talks and courses, I introduce this topic in the same way: “Tell me why you invest for retirement.” And then I add, “Be specific.”
Naturally, I receive differently worded, but generally similar answers: “for the future”, “so I can be comfortable when I retire”, “for my retirement.”
And then someone finally says, “So I can continue to live in my house”.
Bingo.
We invest for retirement so that we can maintain our standard of living. We want to maintain our purchasing power. Once we have our benchmark then we can put numbers into the equation.
What eats away at our purchasing power? Taxes and Inflation.
Once we mention these drains, we can have a conversation that’s not emotionally based. Instead, it’s a factually driven conversation where real decisions can be made and measured by whether they accomplish the goal.
Inflation at 3.5%? Taxes at 30%? Suddenly, it becomes clear that our 2.5% “safe investment” choice is often not a safe investment.
Reframing Risk-Reward
My conversations with pre-retirees suggest that some of them continue to elect the perceived safety of lower-yielding investments without regard to beating taxes and inflation. How many do this is difficult to accurately quantify. However, the government’s defined contribution plan, the TSP (Thrift Savings Plan), does keep those records on its participants.
As of March 31, 2024, 25.7% of participant’s assets were in the TSP’s G Fund that has earned 1.96% for the year, as of June 11, 2024 (vs. 13.65% for the S&P 500). The G Fund is marketed as a government bond fund although returns would suggest it’s closer to a money market fund with slightly higher returns.
But when we can reframe this risk-reward conversation for investors, it forces them to ask questions they might not otherwise consider.
‘They Put Everything in Cash’
An attendee at one of my courses recently shared their financial story with me, which illuminates why investors need this kind of guidance. The conversation came up as we were talking about retirement and lifetime income. The individual, the only spouse with a retirement account, told me that the couple had decided to put everything in cash because it had become too stressful for them to watch the market gyrations.
After a couple of years in cash, the couple was now looking at a fixed annuity and analyzing the cost benefits of lifetime income on the husband’s life. This would provide them both with a higher monthly income; choosing a survivor benefit would reduce the couple’s monthly income while the husband was alive.
The couple was stuck in the process and felt they needed to make a decision soon to capitalize on high fixed rates in the annuity. The husband asked what I thought about their potential move and what advice I might have for them.
Because I no longer carry SEC registrations, my advice consists of asking questions to help people determine their own answers.
The Benefits of Fuzzy Thinking
Investors often see things in black and white but instead I encourage them to do “fuzzy thinking.” I start with what I call the 7 Questions (who, what, when, where, why, how, and how much). While they’re not applicable to all decisions, I advocate using them because it helps people break out of their thinking patterns. I then continue to ask probing questions. The process usually ends with people better understanding the complexity of these decisions and crystallizing what’s important to them.
Here are some of the questions I asked the man mentioned above:
How much do you need to meet monthly financial obligations?
How much will your wife need to live on once you die?
If you choose a lifetime annuity based on your life, how will your wife earn additional money to meet monthly obligations?
Have you identified other investments that might get you where you want to go?
When are you planning on retiring?
If you continue to work for a few years, can you afford to put more aside for retirement?
The answers I received, respectively, were:
We’ll need all the money the life-only annuity provides in order to live
She’ll need the same amount or more, with inflation.
She’ll be too old to work, I have no idea how she’ll earn the money. Social Security won’t cover what she needs.
No, we were basing our decision on market gyrations.
I was hoping to retire in the next five years.
Yes, we can sock away additional retirement money between now and my retirement.
No Second Guessing
As we went through this process, some of the decisions became obvious: The couple need more money and working longer would help. Choosing an annuity on the husband’s life only would not be the right long-term solution, since it would leave his wife without enough resources. In fact, maybe a fixed annuity wasn’t the clear choice for all of the retirement money.
I try not to second guess a past decision, because nothing good comes from that. But, if the couple had asked me before pulling their money out of the market, I would’ve have asked them how safe they’d feel in a couple of years knowing they had lost purchasing power by making that decision.
I’d also have encouraged them to take a closer look at what risk really means and then I’d have suggested they review the investment mix in the portfolio and modify it to smooth out the bumps.
When our conversation ended, the man felt like he gained clarity and a new way of thinking about the choices. As he left, I reminded him that doing the math on these decisions was critical. That while moving to “safety” might feel like a good move emotionally, mathematically, it was difficult to support.
Looking Ahead
A 2023 Wall Street Journal article, “America’s Retirees are Investing More Like 30-Year-Olds,” examined the phenomenon of retirees increasingly tossing away the standard investing wisdom of moving to safety as we age in favor of embracing equities for growth and income.
In the article, author Anne Tergesen states, “Nearly half of Vanguard 401(k) investors actively managing their money and over age 55 held more than 70% of their portfolios in stocks. In 2011, 38% did so. At Fidelity Investments, nearly four in 10 investors ages 65 to 69 hold about two-thirds or more of their portfolios in stocks.”
“And it isn’t just baby boomers. In taxable brokerage accounts at Vanguard, one-fifth of investors 85 or older have nearly all their money in stocks, up from 16% in 2012. The same is true of almost a quarter of those ages 75 to 84,” Tergesen writes.
Naturally, this strategy can be risky, depending on the economy and the relative strength and earning power of fixed income over equities. But by helping clients understand a measurable metric, portfolio balancing becomes less standard wisdom and more good sense and math.
llene Slatko, CEO and founder of DSS Consulting, coaches clients on building strong financial decision-making skills. Her focus is most often women dealing with the long-tail of a divorce or the death of a loved one. Ilene’s new project, Metamorphosis, an e-learning platform designed specifically to guide subscribers through pre-retirement and retirement issues, has just been awarded Runner-Up in the For-Profit Financial Education category by the Money Awareness and Inclusion Awards (MAIA). She spent over 25 years as a financial advisor and built her business through her seminar series, “Women and Their Money.” Ilene is also a subject-matter expert on the Federal Employees Retirement System (FERS) and speaks to civil-services.
