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