Investors are well aware of the importance of contributing to a sound retirement investment plan. But a lengthening lifespan stresses the need to keep our portfolios growing all throughout retirement. You’re the one who should be retiring, not your investment plan.
By necessity, today’s retirement holdings are very different from those of a just a few decades ago. Retirees used to be able to move all of their investments into bonds or Treasuries and simply live off the interest while using up a little bit of capital each year for some 10 to 15 years or so.
Yet with today’s healthier and more active lifestyles, retirees can easily live into their 90s and beyond. We can’t just eat away at our nest eggs anymore; they have to replenish themselves at least at the same rate as we consume them for what can be an additional 30 years after retiring or longer.
Factor in today’s exceptionally low interest rates, which PIMCO’s CEO Mohamed El-Erian calls the “new normal,” and the retirement portfolio of today has undergone an extensive makeover. It simply cannot be as conservative as before.
Thankfully, a longer life expectancy allows today’s retirement plans the luxury of time. We can now take advantage of that luxury by adjusting our portfolios to include instruments that need a little time to produce.
A Broader Equity Mix
Where retirement plans of old may have had as much as two thirds in bonds and one third in mature dividend-paying equities, the extra time on our hands today allows us to flip the pie upside-down, putting two thirds in equities and one third in bonds, depending on how deep we are into retirement. Though a 50-50 split between bonds and equities is likely to be the preferred allocation in these still uncertain times.
The equity portion can next be spread out a little more evenly among the full spectrum of equities. Instead of relying almost entirely on mature dividend stocks, today’s retirement portfolios have the time to benefit from value stocks that need a few years to catch up to the higher value of their peers, and growth stocks that still have years of expansion ahead of them.
Peripheral Equities
The longer duration of retirement also allows retirees to venture just a bit outside of their homeland into the broader global marketplace, as an extended low interest rate environment at home favors strong appreciation abroad for some time yet. However, being smaller and less developed makes foreign economies highly volatile, as was witnessed just this summer.
If you are unwilling to give foreign equities 5 to 10 years to ride the next global wave back up again, you might simply opt for domestic companies that have a strong presence in foreign markets. You could thus have the best of both worlds, gaining exposure to foreign economies during periods of global expansion while still benefitting from the stability of the companies’ business activities back home.
Included in these peripheral equities are commodity and resource stocks, such as mining and energy companies. While similarly susceptible to global economic cycles, resource stocks are regularly among the first to rise immediately following a recession and do not require a large investment to produce a sizeable return when global conditions improve.
The Dividend Mainstay
Included in our equity mix, of course, is the always highly recommended allocation to dividend stocks, which many suggest should be no less than one third of your equities to as much as one third of your entire portfolio. Alongside bonds, dividend stocks are invaluable in providing supplemental income to avoid depleting our total balance.
One point to note on dividend stocks is that not all focus on the same priorities. Some dividend payers are still focused on growth, keeping their distributions relatively small while reinvesting the remainder of their earnings into continued expansion.
But if your portfolio already has value and growth stocks as part of your equity mix, then you can aim your dividend allocation more specifically to those companies that maximize yield at the expense of growth. BDCs – Business Development Corporations providing corporate financing – are among that group, as their classification requires them by law to distribute 90% of their earnings to shareholders.
Other income options include MLPs (Master Limited Partnerships), which invest in energy projects, and REITs (Real Estate Investment Trusts), which own residential and commercial properties. These two high yielding classes, along with BDCs noted above, have traditionally performed better than bonds in rising interest rate cycles, since bonds lose some of their principal as rates rise.
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The Laddered Approach
In broadening out our retirement portfolios, we now find ourselves needing to pay a little more attention to periodic rebalancing. Gone are the days when you could just put your account on autopilot and simply collect your distribution checks. A more diversified mix requires a little more care and attention.
Since interest rates are expected to rise in the future and continue doing so for some time, we would be prudent to use a laddered reinvestment structure for the bond portion of our portfolios. This entails keeping maturities fairly short, fanning them out from six months to five years in order to take advantage of rising rates once they finally begin to climb. Every six months, each expiring bond would then be rolled into a new five year bond, moving from the front of the line to the back of the line, locking in progressively higher rates as they come.
A higher allocation to equities would also require periodic rebalancing to lock in profit from winning positions. These capital gains could then be reinvested into more dividend stocks or bonds, increasing your fixed income allocation and improving your income.
You have spent your entire adult life working for your money; it is now time for your money to work for you. Changes in monetary policies may have lowered our fixed income disbursements for the time being, but they have also opened up other opportunities in equities which still have more years to run.
Don’t be afraid to tap into that side of the financial marketplace just a little bit more, knowing you have the extra years in your life expectancy to derive benefit. At the same time, remember to take profits regularly and boost your fixed income holdings as you go. In so doing, you will not only have a solid income stream, but an ever increasing one at that.
Joseph Cafariello
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