As an individual investing in a 401k, there are many things you can do to ensure that you get to a healthy retirement: saving more, working longer, and certainly using a Dynamic portfolio that relates more to wealth rather than last year’s hot investment.
For those who are lucky enough to have lived, accumulated and retired at the right age, it does not matter what allocations you have. However, for those who entered retirement around 1965, or in the past 10 years, the risk of running out of money is much greater.
Wealth and Returns
In Investing for Retirement: The Defined Contribution Challenge, Ben Inker and Martin Tarlie, both from GMO, suggest — and I reiterate in The 401k Retirement Challenge and Static and Target Date Funds – a Curse on the Industry – that individuals focus more on wealth than they do returns. This is no small feat. Between CNBC and the press blaring what current returns are, it is hard for individuals to turn the other way. More specifically, Inker and Tarlie state:
“We believe that the right way to build portfolios for retirement is to focus on how much wealth is needed and when it is needed, with a focus not on maximizing expected wealth, but on minimizing the expected shortfall of wealth from what is needed in retirement.”
This suggests that 401k investors take a different approach. The premise of this course is to focus on the wealth that is necessary in order to get to the desired goal (note that this approach does not discuss returns or benchmarks).
- Determine how much you want/need (i.e. an investor thinks she needs $50,000 a year in retirement).
- Determine what value you will need in your portfolio to achieve that income (ex: $800,000 at a 5% constant withdrawal rate).
- Decide how much you will need to save and contribute to the portfolio to reach this goal.
- Design a Dynamic portfolio to accomplish the expected goal.
- Review the portfolio annually. Look at where you currently are versus the progression to the goal. Draw a line and a glide path to get to that goal with reasonable expectations. Ask yourself why you may be above or below that line and what might you need to do in order to stay at — or rise above — that line.
The industry — and especially 401k providers — seem to think investing more aggressively at a young age and reducing stock exposure is the way to go. Many of these investors are under the belief that once an individual enters retirement, any and all short-term losses are simply not recoverable.
Forecasting for more than one year out is difficult for most people. Regrettably, valuations do not tell us much about what will happen in the coming week, month, quarter or even the next few years. However, valuations can tell us the expected investment returns over the course of a 10, 15, and even 20-year period of time.
Individuals have come to believe that they should expect 10% in returns. Why shouldn’t they, given the recent strong returns over the last 5 years? Nonetheless, it’s important to remember that investment returns of the stock or bond market are anything but constant.