This is the fourth part in a series of posts that discuss strategies to make retirement plans “better.” If you haven’t already, check out the previous parts to get a fuller understanding of the journey so far.
In the introduction, we explored what makes a retirement plan “better.”In Part 1, we discussed how most financial planning software is overly conservative, preventing retirees from fully living out their “why.”
Part 2 and Part 3 introduced the two strategies that actually make plans better:
- Splitting assets to increase return over the life of the plan without increasing the plans risk.
- Reframing plan risk and adjusting spending during the plan’s life to mitigate risk further.
Most people think investing is simple: buy the good stuff, avoid the bad stuff, and watch the number grow over time. I wish it were that easy.
I might think Nvidia is the greatest stock in the world. It’s been an incredible performer—up about 4000% in the last five years. But it’s also lost over half its value twice in that same period. That kind of volatility is a disaster if you’re relying on it to cover retirement expenses.
As a result, we have to approach investing starting with risk. Rather than focusing solely on returns, we first determine how much risk a client can comfortably take to achieve their goals. Then, our job as managers is to maximize returns for that acceptable level of risk.
Traditional vs. Purpose-Driven Investing
In traditional financial planning, the goal is simple: make the portfolio last until death. Typically, this involves a blend of growth investments and safe investments—a mix of shorter-term assets (like bonds for near-term spending) and longer-term assets (like stocks for future spending). In other words, all the money for every goal goes into one "bucket."
A better approach is to segregate assets into separate buckets with different investment objectives. Clients tend to think this way naturally, a process called “mental accounting”. So bucketing their goals into different investment objectives is more intuitive for clients, and can help make the plan a little clearer.
In addition, bucketing can have a large effect on client’s behavior. A plan killer is when an investor is frightened by volatility in the markets and bails out. If a client has confidence that their spending needs are segregated to their most stable investments, it will allow them to “ignore” some of that volatility, as its only affecting the buckets they’ve agreed they won’t need to use for a long time, if ever.
Finally, with the strategies outlined part 2 and 3 allowing us to increase both spending and legacy objectives, we should be more purposeful about how we invest each bucket.
Bucket 1: For core, non-discretionary spending, we should be conservative. This could mean investing in inflation-protected securities like TIPS to effectively guarantee that portion of your spending. These expenses are your bills, your groceries, your car, the things you need to live a comfortable life.
Bucket 2: Once core spending is covered, we should add a discretionary spending component. This is money for things like vacations or home projects—spending that’s intended but flexible. To maximize this bucket, we take a little more risk in exchange for higher returns. This discretionary bucket can be invested in a blended portfolio, where adjustments are made based on performance—spending more in good years and pulling back during tougher times.
Bucket 3: For those who want to “die broke,” we're done. Spending is the only goal. But for most clients, there’s often some leftover money after accounting for all spending needs. This remaining amount is then assumed to be for legacy goals—whether to support family or charities. This bucket has a longer time horizon than the rest of your financial plan and should be invested aggressively, such as in our Enhanced Growth portfolio.
Practical Considerations
The order of events described above—taking care of spending first, then planning for legacy—is typical for most clients. However, the approach is flexible. You could decide on a legacy amount first and then determine what’s available for spending afterward.
There will also be overlap in how the various goals are invested, allowing for simplification. For example, the non-discretionary spending bucket (primarily bonds with inflation protection) and the discretionary bucket (a blend of bonds and growth assets) can be managed together. Depending on how much discretionary spending you’re aiming for, the blend might lean more aggressive or more conservative.
For the Enhanced Growth bucket, sizing based on the "leftover" amount is a great start. But keep in mind separating stocks into a separate bucket also helps mitigate sequence of return risk. That means a portion of your spending buckets should contribute to the Enhanced Growth bucket, to make the plan more resilient to bad market timing. You could think of this as an “avoid sequence of return risk” bucket, though it’s often merged with the legacy portfolio.
Sizing this portion is a bit of art and a science—unique to each individual’s situation. We would model different allocations and see how each one affects the broader plans risk and spending/legacy amounts to determine this bucket's size.
Moving Forward
Making financial plans “better” starts with the strategies we discussed in Parts 1-3. Making these adjustments is crucial, but incomplete if we don’t align the investment portfolios with your specific goals. This section highlights how we optimize the investment approach once those strategies are implemented, by matching the investment risk to each goal, or "bucket."
Next up, we’ll move beyond concepts and present realistic, life-like case studies that reflect how a client would implement these strategies. Stay tuned to see these ideas in action.
At WJ Interests, we help you move beyond traditional retirement planning to maximize your wealth and live out your goals. As a trusted resource in Sugar Land, TX, we’re here to guide you toward a confident, meaningful future and lasting legacy. Contact us today to explore how we can help you achieve your financial vision.
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