Q: I live a pretty simple lifestyle, but I’ve got more money than I ever expected to have. A lot of that has come because I put money in the stock market and just let it ride. Is it best to keep doing that, or should I diversify into real estate or something else?
If you’re still working and ten years (or more) from retirement, most financial planners would tell you to let it ride. If retirement is getting close, however, it’s probably time to start moving some of your money toward guaranteed income. And yes, real estate can be part of the growth side – for people who know what they’re doing.
What you should do now depends on where you are now.
We all go through three stages in our financial lives: accumulation, distribution and legacy. You might also call them saving, spending and leaving. This week, let’s look at the first two.
- Accumulation: the saving years
Unless you were born into wealth, you probably began your adult life broke (or close to it). You got a job, and somewhere along the way, you learned it was a good idea to save. Then it sounds like someone convinced you to invest a portion of those savings in the stock market. So far, so good.
If you’d started investing at the beginning of 2011 and put your money primarily in the broad U.S. stock market via the S&P 500 (a commonly used stock market index), you would have earned returns of about 14% per year through 2025 (on average).
If you’d started back in 2001, your first few years were pretty rocky. But even after the dot-com crash and the 2008 financial crisis (plus two more bear markets since), you would have earned close to 9% per year (again, on average).
So, the lesson of history (and I think common sense) is that if you’re in the accumulation phase, you have two tools that work well together: time and the markets.
Markets work well in the accumulation phase because they ruthlessly sift through all participating companies and allow those that provide the most value over time to rise to the top. Survival of the fittest, and all that.
But notice those two very important words: over time.
Warren Buffett likes to credit his mentor, Benjamin Graham, with this line: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
- Distribution: the spending years
The reason for the accumulation phase is the inevitability of the last two: distribution and legacy. The clock stops for no one. You may not know when you’re going to retire, or when you’re going to die, but you’re very likely to do the first and certain to do the second. And you’ll run out of money in the distribution phase if you don’t adequately fund it during the accumulation phase. Remember: time and markets.
The main thing to understand about distribution is the radical rule change that takes place. Rather than putting dollars into your investment accounts, you’re now taking them out each month to spend.
Here’s how that rule change can bite. Suppose I had retired at the start of 2000 with $1,000,000 in an S&P 500 index fund. Common advice might have been to withdraw $40,000 per year to live on (plus Social Security).
If I had done that, by the end of 2009, I’d have cut my nest egg in half – less than $500,000 left.
Even if I had wisely diversified 40% of my holdings into bonds, I would still be down to just over $700,000.
Because of the uncertainty of short-term market performance and its long-term effect on retirement income, I like to introduce some risk reduction into a portfolio when it comes time to retire.
This is the unique “superpower” of insurance companies. By pooling the life expectancies of a large number of participants, we can shift that risk onto the insurance company. That allows us in retirement to acquire a guaranteed income for life using a much smaller amount of capital. Think in broad terms of allocating about a third to a half of your retirement assets this way.
That’s where your simple lifestyle pays off. The less you need each month, the more of it a guaranteed income can cover.
Then the other portion of your retirement assets can be allocated to growth investments from which we could logically and historically anticipate appreciation…over time.
- Where real estate fits
So, to your question: Could a portion of this “growth allocation” go toward real estate? Yes, it could, assuming you know what you’re doing (another topic for another column!).
Next time, let’s talk about the final stage of our financial lives – legacy.
P.S. I help family-oriented, legacy-minded people plan for a retirement income that doesn’t rise and fall with the stock market. If that sounds interesting, give me a call (318-251-5858). I’ll do my best to help you figure out what it will take to get there.
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