By Eric Lahaie, JEHM Wealth & Retirement
During the early years of investing, the focus is primarily on achieving the highest rate of return with little regard for safety of principal or liquidity. Most of us started investing through a qualified retirement account, such as an IRA, 401(k), 403(b), or 457 account. These accounts have built-in liquidity barriers, such as a 10% early withdrawal penalty (if you are under age 59½) and unfavorable tax treatment. Because of these barriers, consideration for investment liquidity for most investors is not a priority. Our paycheck and savings support our lifestyle and provide liquidity during our working years. The majority of investments offered in these accounts are market-based strategies that offer little to no protection from market loss. The investment time horizon for weathering the volatility of the stock market is also at its longest. Therefore, little priority is placed on safety of principal. It’s all about how much and how fast you can grow your nest egg!
Once you reach the point in your life where the vision of a comfortable retirement is becoming increasingly clearer (less than a decade away), the elements of safety, liquidity, and rate of return become more relevant when investing. Once you retire, you no longer have the financial stability of a paycheck, and the prospect of losing 40% of your retirement portfolio wakes you up at 3 a.m. with knots of anxiety in your stomach! Now is when the safety of principal and liquidity demands attention! It’s no longer just about rate of return.
Since the priorities for your investments have changed, so should the asset allocation of your portfolio. Understanding your priorities for safety, liquidity, and rate of return will help determine the investments that are most appropriate.
Rate of Return
You can choose to prioritize two of these elements, but you must compromise on the third. Unfortunately, a “perfect investment” (defined as one that provides guaranteed safety of principal, full liquidity, and a high rate of return) just doesn’t exist!
Having a pile of money and randomly picking at it is not a retirement plan! Most of us need our portfolio to provide three main functions: liquidity to cover unexpected emergencies, income to support our lifestyle, and long-term growth for the future. The elements of safety, liquidity, and rate of return have different priorities for each of these functions. General priorities for each of these sectors are as follows:
Emergency: The priorities for this function are safety and liquidity. You need to be confident that these funds are protected from market loss and are available to you in a timely manner without penalty or fee. Where do you keep safe, liquid money? You keep it in a money market or savings account. What rate of return can you expect? Less than 1% in most cases. The priorities are safety and liquidity; you compromise on rate of return.
Income: The priorities for this sector are safety and rate of return (cash flow). Most people prefer a consistent, stable income stream in retirement as opposed to a fluctuating or variable income stream. Generating the highest cash flow by using the smallest amount of assets is also a priority. We must compromise on liquidity (i.e., access to a lump sum of money). Think pensions and Social Security income; both are protected from market loss. Many pensions are insured through the Pension Benefit Guarantee Corporation, and Social Security income is backed by the U.S. Government. Both provide consistent, stable cash-flow. However, access to a lump sum of money is generally not an option, thus a compromise on liquidity may be necessary. Priorities are safety and rate of return.
Future: The main goal for this sector is to grow income and be available for future use. Potentially, this income can be used as additional income to cover health care expenses, hedge against inflation, and fund future discretionary expenses, such as vacations or home improvements. A measure of risk tolerance (one’s ability to stomach volatility) and risk capacity (how much one can afford to lose before compromising lifestyle) is helpful in determining the level of priority for safety, liquidity, and rate of return for this money.
Reallocating your portfolio for retirement readiness can be a complex and daunting task. Employing the help of professionals with the proper education and experience is a prerequisite for putting the odds in your favor when trying to achieve a sustainable livelihood through retirement.
How do you know if you’re working with the right professional? Professional designations are a useful indicator. The Retirement Income Certified Professional (RICP®) is one such designation that indicates expertise in retirement income planning. Professionals who have obtained the RICP® designation have satisfied comprehensive educational and experience requirements specific to the challenges of modern retirement income planning.
Do you have your priorities in order?
Investment Advisory Services offered through Retirement Wealth Advisors (RWA), a Registered Investment Advisor. JEHM Wealth & Retirement and RWA are not affiliated.
CNN Money Link: http://sponsorcontent.money.cnn.com/2016/11/30/impact-partnership/portfolio-priorities/?prx_t=nHkCAI_EKAlF0LA