If you are like many conservative investors nearing retirement, adding a higher rate of equities to your portfolio can seem like risky business. But a portfolio that relies too heavily on fixed income carries its own form of risk. In our low-interest rate environment bond yields are low, and if your portfolio isn’t outpacing the rate of inflation, then you might find yourself running the risk of outliving your portfolio. As investors approach retirement, instead of reallocating to a portfolio comprised entirely of fixed income, investors may be better served with a combination of equities and fixed income to ensure the portfolio lasts for the next twenty-five to thirty years.
The Idea of Taking Risk is Unique to us All
Risk means different things to different people. Many times, risk implies permanent loss. Labeling a portfolio or investment as “risky” doesn’t really help us define how that investment will perform over the long term, or whether that investment belongs in the portfolio in the first place. When talking very broadly about stocks (equities) or bonds (fixed income), labeling these asset classes as risky doesn’t help much at all. A better way to define these two categories is using a measure of volatility. It is true that equities are more volatile than fixed income. Stocks fluctuate more than bonds on a daily basis and for many investors, looking at the daily volatility of their portfolio will drive them crazy! Volatility isn’t necessarily a bad thing—it is finding the right mix of stocks and bonds in a portfolio so you aren’t making major changes over normal market fluctuations. Over time, investors are rewarded for taking on more volatility, as stocks outperform bonds in the long run.
Parents are a child’s first and most important teachers. Natural learning opportunities arise daily to teach children lessons in health, safety, manners and morals: eat your vegetables, don’t touch the hot stove, always say “please” and “thank you”, and treat others the way you wish to be treated. All are essential truisms for leading a productive and satisfying life. Just as learning and living these lessons will help forge a path to a successful and happy existence, instilling solid financial values early and often can set children on a healthy financial path and help avoid common but painful financial pitfalls later on in adulthood.
Teaching children the importance of prudent money management is a lesson that is sometimes neglected by even the most caring and astute parents. Among the many crucial lessons children learn at home from their parents, basic financial literacy is often overlooked. Sometimes parents skip this lesson because they themselves struggle with understanding core financial concepts. If parents, as natural family teachers, fail to take the lead by modeling unhealthy attitudes towards money and its true value, children may grow up gaining independence in every aspect of life except when it comes to their money. Achieving a certain level of financial independence is essential to being successful as an adult. Parents can attain much peace of mind by educating themselves on basic financial literacy and passing that knowledge down to their impressionable children.
Distraction from the media, uncertainty or volatility in the markets, or pressure to buy and sell from friends, colleagues, financial “gurus” and other less than reliable sources for investment advice can directly challenge an investor’s ability to make consistent, rational and logical investment decisions. The barrage of information coupled with some inherent behavioral biases can make long term investing a challenge for most people.
Behavioral Finance has been an academic area of study since the early 2000s when Daniel Kahneman, a psychology professor at Princeton University published research that demonstrated “repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty.” Dr. Kahneman’s findings won him the Nobel Prize in economics in 2002 and the research strongly suggests that investors will often make decisions based on their emotions rather than on logic and historical data, even if it is right in front of them.
In a perfect world, planning for retirement should be exciting (I can’t wait to retire early!), easy (automatic savings/contributions) and not stressful (I have so much money to save!)
In reality, thinking about retirement can make people feel very anxious. How much should I be saving? Will I have enough to live? Will I run out of money? Planning for the future can be very overwhelming and it can be difficult to picture how saving into an investment portfolio can actually provide an income for you when you are no longer working.
Many times, people don’t realize the importance of starting to save early on. The earlier you begin to save money for retirement, the more successful you will be. You will have saved more dollars, and you are giving it a longer time to grow and earn interest.
As we get older, the idea of no longer earning an income and receiving a paycheck is hard to comprehend. We’ve seen a lot of our clients fearful of making a mistake as they near retirement and they become very fearful of market declines. As you approach retirement, it is so important to discuss any concerns that arise with your trusted advisor.
As financial planners, we hope our clients can achieve a peaceful transition into retirement. Here are a few suggestions:
Your time has finally come. You spent your years since high school scraping by on ramen noodles and pulling all-nighters so that you could score that great job, right? Now you have paid your dues for a few years and the time has come for you to get a raise or a bonus. This is certainly a cause for celebration!
Rewarding your hard work with some new clothes, a night out on the town or possibly something bigger like a new car is okay, but don’t get too carried away. It is important, to maintain a sharp perspective on your cash flow and your goals when your income begins to increase.