Investors with retirement on the horizon often communicate two competing primary goals: First, they want to avoid running out of money and; Second, they want to protect their invested principal. I have heard these two disparate objectives repeated together hundreds of times over the years. I’m not sure any of those expressing these goals realized how different these outcomes really are from a planning perspective.
To be clear, these are nice sounding goals but they avoid the objective we work on the most with clients, namely, growing investment income in retirement in order to offset inflation.
Protecting Your Why
Protecting invested principal isn’t really what most investors want; they actually want to protect their lifestyle. Since living cost increases are inevitable, any sustainable financial planning approach must address how to deal with these increases; otherwise, your lifestyle suffers as inflation erodes purchasing power.
The chart below details the increasing income needed after 10, 20, and 30 years, (the average retirement is about 21 years), to maintain an annual retirement income need that begins at $100,000 per year.
This chart assumes annual inflation of 3% which is higher than what we have experienced in the past 15 years or so but closer to longer-term observed inflation rates. For someone born in 1960, the average annual inflation rate for your lifetime is about 3.7% per year.
So, the real question comes down to structuring your plan and your portfolio to recognize the reality of ever-increasing living costs. How can you BOTH avoid running out of money AND protect the purchasing power of your invested principal?
Don’t Do That!
Well, let’s answer this question first by examining what NOT to do. Many investors nearing retirement believe, in error, that they will need to shift their portfolio mostly to fixed income once they fully retire. However, historically fixed income has not proven to be a good storehouse of value once inflation is considered. That is, much of the time fixed income loses purchasing power. The reality is that money, or currency, is a wasting asset because of inflation.
Fixed income does, however, retain a place of importance, as a buffer against stock market volatility and as a ready source for regular retirement withdrawals for living expenses. Fixed income fits into the Consumption and Contingency Buckets described below.
A Reliable Path
The most reliable path to offset inflation and grow retirement income is through a globally diversified stock portfolio. To be smart about investing, you have to both recognize the long swath of stock market history and act on it! Yes indeed, the stock market is full of uncertainty, but so too is everything else.
The mantra we often repeat here is decades, not days. Anything is possible, some things are probable, and we should embrace these actualities.