This is the third in a series of articles on living to 100 and beyond. This post was originally published on June 1, 2010.

Retirement

Source: http://www.flickr.com/photos/kt/56580816/

In my last post on this series, I took a look into a possible future where lifespans extend out to one hundred and beyond, and the possible changes that will affect the way we plan for our retirement, and the way we will live our lives. In today’s post, I’ll take a look into how we can build our portfolio to help us get there, and which strategies can help out along the way.

I believe in the KISS principle, and I believe that following a few simple investing guidelines will greatly help you toward achieving your goals.

How much do I need?

First, how much do you make now? Are you comfortable with your current lifestyle? How much will you need for retirement? 7million7years has posted an income/asset chart which you can check out; his calculations appear to be based on a 5% withdrawal rate, but in order to have a secure retirement, I would recommend going for a 3% max. withdrawal rate.

In order to live on a $50,000 yearly income with a max. 3% withdrawal rate, you should have a total asset base of about 1.6 million. Since inflation is always eroding the purchasing power of our dollars, the equivalent 25 years out at 3% inflation would be a little more than double, or about 3.3 million. This just means you will have to cut back on expenses that much more aggressively!

Building your portfolio

Investing in indexed funds

I recommend that the core of your portfolio be in indexed funds. Why indexed funds? There are a plethora of investment options out there today, countless “get rich schemes“, and countless more scams. It doesn’t have to be so stressful or complicated, however. Just by capturing the total return of the stock market, a $1,000 investment made in 1969 would have grown to $39,770. This is better than most actively managed funds would have achieved for you.

Indexed funds should therefore form a core portion of your portfolio for the long-term. Whenever investing in the stock market, however, it is very important to keep a long-term perspective. If you fail to keep a long-term perspective, then you may fall into a dangerous trap that will destroy your returns.

Although the indexes outperform most of the pros, the average investor actually significantly under-performs this result. Why is that? Well, the average investor buys in when prices are high, and sells when prices are low. When they see the stock market going up, they don’t want to miss the boat, so they buy in. When the stock market crashes, they get fearful and want to sell off whatever remains. This is one of the worst ways to invest in the stock market.

This one mistake alone can absolutely destroy your returns, so as a bare minimum I recommend that you keep it simple and stick to a continuous savings plan that adds to your account over time. Above all, do not liquidate after a stock market crash. Instead of a disaster, such times should be seen as opportunities to get in at cheap prices. Here are a couple of quotes from the Oracle of Omaha that come to mind:

Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.

– Warren Buffett

… Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

– Warren Buffett

The second mistake to avoid would be to buy an equity fund at a bank that claims to be an indexed fund, but charges a 2.00%+ management expense ratio. Compare this to the <0.50% you can often find with companies such as Vanguard. How big of a deal is a couple of percentage points? More than you think. Remember that $1 000 investment made in 1969 that was worth $39,770 after 40 years? Well, shave a couple points off the return and it would only be worth less than half of that value. The other $22,000 would have gone to the mutual fund company and to the portfolio manager.

Investing in bonds

In addition to indexed funds, you can also build up an asset base of bonds in order to complement your portfolio of stocks. The conventional wisdom says that the % of your assets in bonds versus stocks should be relative to your age, so a 40 year old man should have 40% of his assets in bonds and 60% in stocks, however, I will show in a subsequent post how higher equity allocations of up to 75% (and sometimes beyond when the situation calls for it) can make for a higher-performing portfolio, so long as once in retirement, you are withdrawing about 3% max per year.

When you hold bonds, you can take additional advantage of the stock market’s variance, and of investor fears & worries. There are times when the stock market is expensive and then there are times when the stock market is cheap. You want to get more for less, so those times when the market is cheap are great times to build up on your position, by rebalancing and selling off some bonds in order to load up on cheap stocks.

Investing in precious metals

Precious metals are not investments in the traditional sense, since they do not generate income nor do they do any work. They are, however, precious commodities, and gold in particular also serves as a store of value and as an alternative currency.

There are times when investor sentiment is bullish toward paper assets, and then there are times when investor sentiment is bullish toward gold, due to a lack of confidence in paper assets. These are long-term trends, and shifting a portion of your portfolio between, say, stocks and gold can increase your total portfolio returns. I currently aim to keep between 5% and 10% of my investments in precious metals. See Gold as an Investment: Performance over Time and How Gold Can Provide Stratospheric Returns to Your Investment Portfolio… if You Can Avoid the Bubbles! for a more detailed analysis on this point.

Investing in real estate

Your home also isn’t an investment in the traditional sense; it is shelter that provides a roof over your head, the same as a rental would. However, a home can be a great wealth-builder, since it can serve as a giant lever to help you increase your returns.

With leverage available at low interest rates, you can use the equity in your home to invest in other assets and build up your total portfolio of assets. It is one great way to use inflation and leverage to your advantage. For Canadians, it is also a way to convert the non-deductible mortgage interest into tax-deductible investment loan interest. This is otherwise known as a “Smith Manoeuvre“. As a guideline, 7million7years recommends that no more than 20% of your net worth (assets – liabilities) be locked away in your primary home; 7million7years has quite a few posts that go into this topic, and I highly recommend you head over and visit his site.

A couple of things to watch out for when using leverage in this fashion is that should interest rates rise, loan interest will become a lot more expensive, and property values may also stagnate or decline. Leverage also magnifies losses as well as gains, so be careful out there.

The plan

I would recommend sticking to a long-term plan and using indexed funds as the core of your long-term portfolio. Bonds, real estate, and precious metals can then be added to diversify your portfolio and increase returns by buying when asset values are low, and rebalancing when relative asset values are high. I also recommend paying the above linked sites a visit, as my fellow bloggers all have a lot of valuable advice and experience to share. Later on, I’ll talk about building up on medium-term income opportunities that will help you leave the rat race earlier.

So, reader, how are you planning your retirement portfolio? Do you have any recommendations to make? I would love to hear more about your plans.

This post was originally published on June 1, 2010.

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About

Kevin has left the office, and he is currently fighting the rat race by working on his own business. He enjoys exploring unvisited places around the world and gaining new experiences. He believes that by properly managing our energy and time, we can learn to invest our lives wisely.

39 Comments Kevin on May 28th 2012

39 Responses to “Living to 100 and Beyond: Building Your Portfolio”

  1. DIY Investor says:

    Great advice throughout. I would expand on the bond allocation and suggest tilting towards the shorter end of the curve because yields are so low and will likely be considerably higher in a few years as we come out this disinflation period. In the U.S. you can easily do this by buying an ETF with a lower duration than the overall market. I would also suggest looking at corporate bonds because their yield spreads are widening out with the current market turmoil.

  2. re: How much do I need?
    Using various online calculators in the past, I figure we’ll need close to $40,000 K in “retirement dollars” to live comfortably. That’s why I’m getting on my horse to invest in dividend-paying stocks, as passive income will be the only way I can get there. Buying and holding good dividend payers in unregistered accounts is my key investment strategy.

    re: Building my portfolio?
    I agree, never liquidate after a market crash. In fact, buy as much as you can! About 60% of my RRSP is in ETFs that mirror the TSX. The rest, is in bond ETFs. My RRSP is almost completely void of mutual funds, I have only one left. Outside my RRSP, all I own is dividend-payers.

    Your take on precious metals was interesting, as I don’t own any. Do you do this for additional diversification? A hedge against currencies and other assets?

    re: Real Estate? We used to own a rental but I found this tiring (not to mention frustrating). Our proceeds from the condo less capital gains were used to buy Canadian dividend-paying stocks. Sure, different assets, but an income earner all the same. We do own a few REITs, namely REI.UN and HR.UN. I’d rather own part of a billion dollar REIT than a half-owned condo I have lots of debt on!

    Very good post! Keep them coming!
    .-= Financial Cents´s last blog ..H&R Dividend News =-.

  3. Nice post Kevin!

    DIY investor, what do you mean by expanding on the bond position? Are you referring to buying corporates and short term government bonds as well, or adding more bonds to the portfolio?

    Cheers,
    Andrew
    .-= Andrew Hallam´s last blog ..Mariusz Skonieczny — Why Are We So Clueless About the Stockmarket? =-.

  4. AJC says:

    Thanks for the 7million7years mention.

    I think your demonstration of the effect of exhorbitant ‘management fees’ (i.e. push the BUY button, so you don’t have to) is excellent and worthy of a mention on my site … now, I’m off to my excel spreadsheet to validate your calcs!

  5. Kevin says:

    @DIY Investor

    Thank you for sharing those tips. If you see interest rates rising within the next few years (and they probably will), then I see how it can make sense to go with shorter terms now.

    @Financial Cents

    I would like to expand on the passive income theme in a future post, thanks for mentioning that. About precious metals, I think the best time to get into this trend was probably 8 years ago, but I bought into them after the 2008 crash simply because I saw them as being underpriced and suffering from the general market turmoil.

    The main fundamentals I see driving precious metals are:

    – Investor flight to perceived safety: as currencies around the world are debased and nations find themselves in more and more debt, precious metals are seen as a safe haven. Ever since the 2000 dot com bubble bursting, investor confidence in paper assets has been declining and sentiment toward precious metals has been rising.

    – Industrial demand. When I bought the majority of my metals, the prices had collapsed. For metals like platinum and palladium, you have to believe that prices will recover once the economy heats up again. Platinum lost more than 50% of its value right after the crash but has already recovered a significant part of that. It’s similar to the story we saw with oil, which I think would have been an even better play as you would have doubled your money.

    I mainly aim between 5% and 10% for diversification, as a hedge to my other investments, and to continue to ride this wave of sovereign debt worries and currency risk. When I see the tide moving the other way, I will reevaluate my position.

    @Andrew

    I am also wondering about that. :)

    @AJC

    Thanks for stopping by! Those management fees definitely are a great killer over a long period of time.

  6. Mark says:

    Active funds are interesting and shouldn’t be dismissed out of hand. They have a larger range of performance variance and cost more, and certainly selecting the winners is a hefty task, but the best performing funds tend to be active funds. (Check out http://articles.moneycentral.msn.com/Investing/MutualFunds/10-best-funds-for-the-long-haul.aspx?) (as an aside, I quite enjoyed “In the name of affordability, funds also have minimum investments of $25,000 or less”…)

    That said, your point about a personal investor’s behaviour is valid. They tend to behave like very bad, irrational active investors in passive funds! We’ve found that investors in active funds sometimes bequeath responsibility for their decisions because someone with authority is perceived to be on top of things, as it were, but at least they hold out. Young investors of passive stocks move around a lot more than they should do.

    As a principle I think the decreased costs of passive or index investing, given you are secure enough in your decision and can control emotion, more than make up for the foregone (potential) upsides of even a renowned active fund. Don’t make bad portfolio construction mistakes! http://www.spotlightinvesting.com/index.php?readblog+436

    • Kevin says:

      Hi Mark,

      If ever everyone started to invest in indexed funds, then we might have a problem. While indexed funds represent the state of the market, active investors drive the prices by buying and selling. Thus, active investors and actively managed funds do have their place in helping to drive the market.

      However, it can’t be said enough that the regular investor loses out greatly by going with an actively managed fund. This shows that perhaps indexed funds still have significant room to grow, given the vast amount of economic rent that active funds and active managers still collect.

      That said, you make a great point about personal investor behavior. Active or passive, if you don’t have the right mindset for investing then you will get burned. Thanks for stopping by and sharing.
      .-= Kevin´s last blog ..The Joy (And Folly) of Emotions =-.

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  10. There are really some great tips here. Some are obvious once read, so they are a great reminder on what to focus on. I think most important is to remember that investing for retirement is a long term plan, and “do not liquidate after a stock market crash”. The suggestions really help to ensure that you have a well diversified portfolio that will bring in enough return once you are retired.

    • Kevin says:

      “do not liquidate after a stock market crash” indeed! Doing this would only compound the pain. If the stock market was really going to zero then we have worse problems then worrying about financial freedom and retirement.

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  14. Taline says:

    Aricle 3 just gets better!

    I invest heavily in real estate rental properties and in dividend stocks. I have yet to invest in precious metals, however, as part of my diversification plan, I think it would be wise of me to do so.

    • Kevin says:

      Real estate + dividend stocks are definitely good components toward an infinite portfolio.

      I aim to keep around 10% of net worth in PMs these days, and I prefer physical ownership. I see it as something to hold for the long term, as an anti-currency and anti-big government investment. Not as fond of the ETFs and such, though I once turned $50,000 into $250,000 on a forex trading platform by going long gold. If only it was not practice money! ;)

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  16. Glad you republished this, good information. What jumped out at me was the discussion on index funds. People often think about index funds vs actively managed funds, and my thought is that while different funds might be good for different people/situations, it’s a nice thing to keep expenses low in general.

    Also, yes – liquidating after a crash or downward cycle can be a bad move. So many people probably bailed on the market a few years ago, or after the US credit rating downgrade last year. Panic and reactionary moves out of fear can compound problems for people, while in turn giving others a potential buying opportunity.

  17. This is such a great series. I have a good chance, genetically, at being a centenarian myself and would rather not work (at least, not at a 9-5) every day until I die. I am quite sure that I won’t be reaping the same government benefits granted to my 80+ year-old grandparents, either, so it’s nice to think about ways to invest in order to live comfortably later on. How do you make your precious metal investments? Coins? Securities? Do you find one better than the other?

    • Thanks, Wayne! I used to invest in pool accounts, but now I hold everything as physical coins and bars. I think 5% – 10% of net worth is a good place to get started, and you can go to a large, reputable dealer like Kitco. I know what Warren Buffett and others say, but in my view it’s better to look at PMs as currency and not as an investment; think of it as another store of wealth. There’s a reason why many central banks keep some of it in their vaults, and why many eastern cultures place a greater emphasis on it than we do.

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  19. Our original plan was to invest for our future via a 401k, a pension plan, Roth IRA’s, and stocks. Now that my husband and I quit, we are looking into a SEP IRA to replace the 401k and pension plan. BUT, we sort of got distracted and are investing in real estate instead this year (buying a new home and renting out our current one). Life is funny sometimes…

    • Hi Crystal,

      It sounds like a really great plan, especially since you have sane housing prices where you are! I’m worried about the effects that a price drop of 10 – 20% could have on our economy up north.

  20. Shilpan says:

    Real estate is great instrument as it can be leveraged. But, lever can swing on either side. Higher leverage = greater return on investment or greater loss on investment. I can’t agree with you more on index funds.

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