How Should I Invest for Retirement?

Disclaimer: The following is for informational purposes only.  It is not intended to be actionable financial or investment advice. To determine if it's right for you, contact your financial planner.

If you've paid attention the last two weeks, you've learned that:

When you get negative returns doesn't matter if you're in "growth mode" and
When you get negative returns matters A LOT when you're in "withdrawal mode"

If you're invested wrong when you first retire and the markets go down, you could easily find yourself unretired very quickly because you suddenly can't afford retirement.

The wrong way is keeping the same portfolio you had before you retired, but with less risk (ie more bonds, less stocks).

The right way is using retirement "buckets".  There's only two buckets:

Bucket 1 - living expenses for the next 15 years
Bucket 2 - living expenses for all the years after that

Sounds pretty simple, right?  It is.

The reason you divide up your money into different buckets is because each bucket has two different goals. 

The goal for Bucket 1 is to protect your money.
The goal for Bucket 2 is to grow your money.

It's impossible to protect AND grow your money at the same time.  That's why you can't keep the same portfolio you had before you retired.  Back then, you were ONLY growing your money. 

Bucket 1 is invested in cash and investment grade bonds.  The value of cash and bonds don't go up and down.  Except for the small chance of bonds defaulting, you know exactly the interest you'll earn and how much money you'll have when the bonds mature. 

This is what will be paying your bills for the next 15 years, so you want it invested nice and safe. 

I can hear you asking, "If it's nice and safe, why don't I put all my money in cash and bonds?"

Great question!  And it has a one word answer: inflation.

Historically inflation depletes your spending power at 3.74% per year.  In 2017, a portfolio of cash and bonds will earn about 3.74% year, just keeping pace with inflation.    So none of your money is actually growing.  

If you're sitting on a pile of money so high that you can afford to earn a 0% real return (a real return is your return after inflation) and still make it last a lifetime, then good for you!

If you're like the other 99% of us, you need to grow some of your money to stay ahead of inflation. 

Enter Bucket 2, your growth bucket.  Bucket 2 gets invested in a well-diversified equity portfolio using low-cost index funds. 

It will have good years and bad years.   When it has bad years, you just ride it out and don't touch the money.

When it has good years, you trim off the gains to replenish what you've spent from Bucket 1.

And safe retirement investing is just that easy.*  

*Word of caution:  I vastly oversimplified this to explain the concept.  Below is a list of some of the additional things you would need to discuss with your financial planner:

  • Determining your living expenses

  • Social Security benefits strategy

  • How to construct a well-diversified bond ladder for Bucket 1

  • Ways to diversify bond risk

  • What kind of bonds to buy

  • How to construct a well-diversified equity portfolio for Bucket 2

  • What kind of asset allocation to implement

  • How much you actually need to support your lifestyle

  • And many, many, many more (there's a reason there's an entire profession dedicated to this stuff!)