If you have been reading the headlines lately, then you probably know that Greece is on the verge of default and could possibly be leaving the Euro. In 30 days, the Chinese Shanghai composite has lost over 30%, the Dow Jones Industrial Average is down -1% on the year, the Fed is considering raising interest rates for the first time in seven years, and on top of all that, our debt in the United States has now exceeded 18 trillion dollars.
When it comes to investing there is an old saying that “a rising tide lifts all boats” but Warren Buffet really nailed it when he said, “When the tide goes out you find out who has been swimming naked.”[shareable]’When the tide goes out you find out who has been swimming naked.’ – Warren Buffett[/shareable]
When it comes to retirement planning I’ve seen too many people make the mistake of assuming a constant rate of return on their money (around 7-10% per year) without considering how the sequence of those returns can impact their retirement cash flow and investment portfolio. A significant loss the first couple of years of retirement could devastate a entire retirement withdrawal strategy. When it comes to retirement income it is not just the rate of return that matters but the timing of those returns.
The solution to this problem is actually pretty simple: TIME. Time is the cure to the volatility of the stock market. The more time you have, the more risk you can afford to take. When you are drawing money out of a portfolio for retirement income, you want to make sure that income source is safe from market volatility. Taking money out of an account that is falling in value is like donating blood when you have been stabbed and are bleeding. You have a bad situation that is going to get worse.
Diversification of your portfolio in retirement should include two steps: Step one is to diversify your time horizon; Step two is to diversify your investments. Some people call this a bucket approach to retirement income while others refer to it as laddering your cash flow. Essentially income you need for the first five years is safe secure and guaranteed. The more time you have the more risk you can afford to take. If you create a retirement income plan that diversifies time first and then uses the best financial vehicle for that time segment, then you can create a retirement income plan that delivers a great deal of confidence. [shareable]’Time is the cure to the volatility of the stock market. Make sure time is on your side.’ – Jason Parker[/shareable]
The key is to start with a plan, not an investment strategy. It is important that you stick with the plan in the good times and the bad. Unfortunately too many people make projections based on the good times. When the market is going up and the tide is rising, everyone is comfortable with risk. When the tide is going out and people begin to realize their plan is very vulnerable to the whims of the market, those who do not have a good retirement income strategy can begin making emotional decisions, which are usually bad decisions. The best time to buy something is when it is on sale. The best time to sell something is when it is at it’s peak price. When you do not have a good retirement cash flow plan to start with many people end up making the exact opposite decisions. They sell assets when they are on sale, and they buy them when they are expensive.
Stock market volatility is nothing new. It has always been with us and it will always be with us. It is the risk that we are willing to assume that allows us to have the potential to earn a return greater than we might get in a bank certificate of deposit.
When you have diversified your retirement income plan by time and conservatively solved for your cash flow needs, then you won’t have to worry about people seeing you naked when the tide is going out.
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