What Bad Decisions Do People Make in Early Retirement?
When people first retire, they often have a number of of pent-up dreams they wish to fulfill. They still feel healthy and they may want to move somewhere new, travel, buy a boat or RV, and have a little fun. After all, they have waited and saved their entire lives for this moment and they want to enjoy it before age and illness slows them down.
Next, retirees often stop saving and putting aside money for the future. As they pull money from the principal without replacing it, retirees gradually see their assets become depleted.
In addition, retirees sometimes do not prepare adequately for rising expenses or problems that could come up in the future, including extra medical expenses such as health insurance deductibles, expensive treatments, long-term care, etc. They also sometimes fail to prepare for things like replacing their car, hot water heater, furnace or other expensive items.
Even if new retirees do not make any of the above mistakes during their first five years after retirement, their assets could become depleted because of poor investment decisions.
Should You Invest for Growth or Safety?
Investment advisors recommend that your retirement assets should be invested for both growth and safety ... but what is the correct balance? According to an article by CNBC writer, Kelley Holland, "Five Crucial Retirement Years For Your Money," it is extremely important that you do not have negative investment returns during your first five years of retirement. When experts from Prudential Insurance examined two hypothetical $1 million portfolios, Portfolio A had negative returns for 4 of the first 5 years, but positive returns for all of the remaining years of its existence. Portfolio B had all positive returns in the first 5 years, but had negative returns in 4 of 5 years between years 25 and 30.
What were the results? Portfolio A had dropped to zero within 15 years. Portfolio B had doubled in value by the end of 30 years, despite the negative returns at the end.
What Should an Investor Do?
After examining the results of these two hypothetical portfolios, experts believe it is important that investors manage their money conservatively early in retirement so their portfolio continues to grow in value, even modestly, during this crucial period. In order to do this, it would be a mistake for retirees to make risky investments or begin depleting their principal for trips or other large purchases.
Retirees need to work with their investment advisor to make sure their money is wisely invested. Holland recommends that no more than 40 to 60 percent of a retirement portfolio should be in stocks (and, obviously, these should be Blue Chip stocks, not high-risk ones).
As retirees begin to live off their assets, their withdrawals should be modest and their asset allocation should be conservative, particularly during the first five years. In other posts on this blog, we have reported that most investment advisors suggest that no more than 3 percent of assets should be withdrawn for living expenses during retirement, with tiny increases in the withdrawal rate as the years go by. If the principal balance is invested conservatively, the assets of most people should last well over 30 years.
Some investment advisors also recommend that any income from the assets that is in excess of what is needed for living expenses should then be invested in stocks which, hopefully, will appreciate and provide an extra cushion for the future. This extra cushion will be especially helpful if there is a stock downturn in the future ... which is almost certain to happen every few years.
In the end, this plan is the one that is most likely to leave you with enough assets to last the remainder of your life.
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