Two Crucial Portfolio Management Steps For Pre-Retirees

Are you thinking of retiring soon? 

If you are, it’s crucial to plan for this next phase. 

It may be tempting to say, “I’am sick of working for ‘the man.’ ” 

But before taking a big step, be sure you’re heading toward something you desire, rather than running from a suboptimal situation.

We’ve all heard platitudes about money not buying happiness, although a recent study poked holes in that line of thinking. 

But a lack of funds in retirement may result in unhappiness and depression.  In a 2017 survey, the Nationwide Retirement Institute found that more than 80% of recent retirees said money worries made life worse. 

If you are preparing for retirement within the next few years, start asking yourself some tough questions. 

Here are two common questions I get from pre-retirees. 

1. How can I create cash flow in retirement?  

For decades, the common wisdom was to live off the interest and dividends from your portfolio, while leaving principal intact.  

This old-fashioned way of thinking always reminds me of the Monopoly card that says, “Bank pays you dividend of $50,” or the long-ago notion of “clipping coupons” from bearer bonds before investments were stored electronically. 

Today, we have the advantage of empirical research and multiple investment vehicles to bring far more flexibility to cash flow management. 

The challenge for today’s retirees is knowing how to generate steady income from their various investments. Withdrawing from the wrong investment at the wrong time can have lasting effects on the sustainability of a portfolio during retirement, and could result in a big tax hit. 

 A well planned cash flow strategy takes into consideration: 

• Sources of income such as Social Security, a pension, part-time work or rental income
• The  correct mix of stocks, bonds and cash based on your unique risk profile.  Just think of Goldilocks: It has to be “just right” for you. 
• Tax consequences of withdrawing from different investments and types of accounts, such as annuities or Individual Retirement Accounts.  You must also evaluate the effects of capital gains taxes when you sell  selling highly appreciated securities in a non-qualified account.
• The correct assets to sell, to generate the cash you’ll need. It’s more than just picking something that has done well or poorly. Your remaining investments must be tailored for your goals, time horizon and risk tolerance. 

 If you are close to retirement, be sure to have short-term bonds and some allocation into cash. This allows your portfolio to weather a market downturn with less damage than a portfolio of all stocks

Owning too many stocks hurt a lot of investors back in 2008 when the market crashed. Although a new generation (or two) have entered the market since then, plenty of Boomers and members of the Silent Generation recall the damage vividly. 

I’ve heard way too many stories of retirees losing half of their hard-earned savings. Often, they were working with a stock broker (rather than a fiduciary or financial planner) who didn’t understand asset management strategies.

Fortunately, the market is littered with far fewer of those know-nothings today, due to regulatory changes and better information among consumers. 

Had someone with a fiduciary duty been guiding those investors during that crisis, there would have been some type of asset allocation strategy designed to protect assets in a downturn. 

In most cases, retirement investors who planned properly before the financial crisis were  at least back to even, and usually better, within a couple of years. 

I recently had a client, William, who come to my firm for help in generating income starting at age 66. His plan was to spend down his cash and then take Social Security at age 70, so his benefit amount would grow. The task was to figure out the best way to replace funds he would have received from Social Security had he begun claiming his benefit at age 66. 

Required Minimum Distributions (RMDs) must be taken out of many retirement accounts at age 72, although account owners may also draw from these accounts, penalty-free, any time after age 59 1/2.

In William’s case, taking distributions from his IRA, starting at age 66, accomplished a few  goals: The income was enough to meet his needs, his taxes were spread out over a longer period of time and the retirement account value declined. That lower value was a good thing, because it reduced the amount he would need to take later, at age 70, when Social Security kicked in.

My job was to determine which assets William should liquidate to raise the cash needed for his distribution.  That decision must be made close to the planned sell date, as it is governed by several factors, including market conditions, interest rates and capital appreciation.

  2. Which is better? A traditional IRA or a Roth IRA? 

This question that comes up frequently, accompanied by that frustratingly enigmatic answer: It depends. 

Here’s the deal:  Contributions to a Roth IRA are made “after tax.” In other words, you get no tax break at the time you put money into a Roth. What’s the advantage? You don’t pay tax on your Roth distributions later on, when you make withdrawals in retirement.

With a traditional IRA, you won’t pay taxes on the amount you contribute. However, Uncle Sam eventually gets his share: You will pay taxes when you withdraw that money. You may withdraw the money penalty-free after age 59 ½, but you are required to make withdrawals starting at age 72.

A Roth IRA does not require that you make withdrawals at that age, as you’ve already paid taxes on the amount you contributed.