8 Retirement Portfolio Red Flags > By David Fabian Investors that are in or nearing retirement have to think differently than those in the growth phase of their life cycle. If you have been fortunate enough to amass a sizeable nest egg, rule number one is to not lose it. Rule number two is to not let anyone else lose it for you. Topics such as income needs, risk tolerance, asset allocation, security selection, and choosing the right advisor to implement a coherent strategy are crucial decisions. This will likely be driven by a mix of your personal investment philosophy, market outlook, and other exogenous factors. Remember that every household is unique and should be treated accordingly. You may think that you want the exact same solution as your neighbor. However, they may have completely different factors that influence their investment strategy and may not be appropriate to meet your goals. No matter what your situation is, these red flags come up repeatedly when I am doing portfolio reviews for prospective clients. I urge you to be cognizant of avoiding these pitfalls as you are implementing a realistic retirement portfolio that will go the distance. Commitment to high fee mutual funds High fee mutual funds are still one of the worst ways you can invest your money in the stock market. Here are the two main problems with these legacy products: (1) they create a phantom drag on performance by the nature of their exorbitant expenses and (2) they are susceptible to underperforming a passive benchmark with little marginal alpha in the rare event they outperform. I m not here to tell you that you need to be 100% passively indexed to a basket of exchange-traded funds. However, you should be consistently monitoring the progress of any mutual funds versus their
peers to determine if they are adding value. There are still a handful of funds that do offer unique strategies or consistent enough performance to warrant your money, but they are few and far between. Often these are kept in your portfolio because you or your advisor are just too lazy to change them out. There may also be barriers to exit such as redemptions fees or other hidden incentives for your manager that you aren t aware of. Shotgun approach to security selection When in doubt, just own 3 or 4 of everything. This is the motto of many portfolio managers who are trying to appear sophisticated by loading you up with 20, 30, or 40 funds. Do you really need 3 large-cap value mutual funds? Trust me, they aren t going to be that different at the end of the day. I call this approach the shotgun method because these portfolios are just predicated on the notion of a high volume of holdings to spread your wealth around and create maximum confusion. A more targeted or sniper-like approach is to hone in on the core areas of your portfolio that you can own in just 3-5 low-cost index funds. This will still result in a well-diversified retirement portfolio that is easier to track and understand on a long-term basis. Then you can add in some additional tactical positions to gain exposure to specific themes or other sectors of the market that you believe will outperform. High allocation to money market or low duration bond funds I reviewed a portfolio from a local advisor that was 25% cash and 25% low-duration bond funds. Let s face it, that s 50% of your portfolio that won t earn more than 1% in the current market environment. The investor who shared this information with me stated that his account had been in that state for the last two years and the advisor is just being cautious. You can spend years of your life and waste precious opportunity by waiting for the next bear market to appear. Meanwhile, with 50% of your portfolio virtually in cash, you are now asking the remaining 50% to pull the entire load in generating your returns. This means that to achieve a 6% total return, the 50% that is truly invested will have to rise by 10%. That just not a feasible approach to generate the type of consistent and steady gains you need to reach your long-term goals. In addition, there is no guarantee that this advisor will end up putting that money to work in the market when there is a significant dip. If they haven t been disciplined enough to invest this capital for two years, why is there any reason to believe they will change their tune near the market bottom? Don t let fear keep you from implementing a balanced and steadfast retirement income portfolio.
Over dependence on high yield One of the problems that the 2015 market flushed out was the overdependence on high yield securities. Junk bonds, master limited partnerships, bank loans, and other credit sensitive areas took a big hit in their prices as income investors moved to a risk averse stance. If you were unfortunate enough to feel significant pain from this recent down cycle, then it highlights a fundamental flaw in your strategy. There is no free lunch when it comes to high yield. The promise of greater income also comes with it an associated cost in higher volatility and potential loss. I have always advocated taking a conservative stance by pairing high quality and high yield securities together in order to mitigate the effects of this volatility. That way you are still able to maintain a reasonable yield without taking too much risk. Worrying about things you can t control Worries over political, social, and economic cycles that induce fear-based investment decisions are one of the biggest mistakes I see retiree s making. Some examples include: fretting about who the next president will be, when the Fed will raise rates, how taxes will change in 10 years, or how the socioeconomic picture in China will impact our lives here at home. I haven t met a retired investor who isn t worried about what is going to happen to the U.S. dollar and the impact of inflation on their cost of living. All of these concerns are certainly valid, but the first step in dealing with them is realizing that worrying isn t going to solve anything. There is nothing that any single individual can do to impact the outcome of these events or forecast how they will move the markets. The reality is that watching 16 hours of Fox News, CNBC, or MSNBC every day isn t going to provide any answers either. In fact, it can lead to poor decisions during even brief corrections that are born out of fear of loss rather than sound portfolio management choices. It can also result in trying to time big events such as a Fed rate hike by making significant asset allocation changes based on what you think should happen rather than what does happen. The reaction to the news is often times more confusing than what traditional logic would dictate. The bottom line is that the markets aren t logical, they are psychological. That is why investing is so difficult and requires a great deal of planning and discipline to execute successfully.
Having to prod your investment advisor An open dialogue with your advisor is a crucial component of a successful relationship. My favorite clients are the ones who challenge me with fresh ideas or ask questions to better understand their opportunities and risks. However, if you find yourself constantly prodding your advisor to move to lowcost ETFs or develop a clear strategy, then are you likely in a toxic relationship. Many advisors are better salesmen than portfolio managers. Putting together a sensible portfolio isn t on the securities exam to be licensed in this business. They may also be financially motivated by other hidden factors to keep you in certain investments or to remain as passive as possible with your portfolio. Your advisor should be compensated in a fair arrangement that places your interests and theirs on the same side of the table. They should also be motivated to place you in the lowest cost investments to achieve the best returns. Lastly, they should be implementing a cohesive strategy that resonates with the current market environment and makes sense with respect to your personal investment philosophy. The grass isn t always greener in an annuity The lack of consistent returns is a frustrating facet of investing in stocks and bonds. Rather gains come in unpredictable cycles that are often difficult to capture if you aren t disciplined with your investment decisions. This frustration may lead to some investors shopping for a guaranteed alternative that usually takes the form of an annuity. Many investors simply give up on the investing game and turn their retirement portfolio over to an insurance company to provide a lifetime income stream. This is what s known as an immediate annuity. While the allure of a guaranteed income stream can be attractive, it also comes with risks as well. Namely giving up all your liquidity and the lack of flexibility. What if you needed a lump sum of money all at one time for an emergency? What legacy will you leave your children or other heirs? Do you fully understand all of the costs and fine print in these products? These are just some of the important questions that will need to be answered in order to determine if an annuity is right for you. The grass isn t always greener when it comes to analyzing the pros and cons of these income alternatives. Living an unrealistic lifestyle Another big mistake that I see many retirees make is relying too heavily on their investment portfolio to fund an unrealistic lifestyle. Let s face it advancements in the medical and health education fields are leading to a much longer life span than many people anticipated. Rather than relying on the income generated by your portfolio lasting 15 or 20 years, it could easily need to be stretched to 30 or 40.
In order to combat this issue, you should be regularly evaluating the annual income generated from your portfolio, your living expenses, and market factors that may affect your account balances. It s imperative to maintain a withdrawal rate that is realistic enough to be replenished through capital appreciation or income generation. Any shortfalls may need to be solved through a reduction in discretionary expenses or adjustment to your investment plan. This is a regular exercise that a trusted and competent investment advisor can help you implement as well. The Bottom Line A successful retirement requires a well thought out investment plan combined with regular maintenance to ensure you are on the right track. In addition, it should be a priority to disengage from the wall of worry that pervades our everyday lives. Stay focused on the things that you can control such as your investment decisions, asset allocation, expenses, and advisors. Start by writing down a list of your goals by order of importance - i.e. capital preservation, income, growth, leaving a legacy to heirs, etc. Once you have completed this exercise, you can review your advisory relationship or investment philosophy to ensure they align with your needs. Make sure that any changes are implemented after suitable due diligence and with patience to ensure you don t experience any setbacks. Success requires planning, and planning for success is what we do at FMD Capital Management. We are a fee-only wealth management firm that helps clients achieve their goals by providing a clear investment plan and implementing it decisively. We pride ourselves on providing our income clients with open communication and a structured risk management approach to minimize volatility whenever possible. Contact us today at 888-823-8111 or visit www.fmdcapital.com to request a free portfolio analysis or help constructing a retirement income portfolio to meet your needs. The information expressed by FMD Capital Management is for informational purposes only and should not be construed as a recommendation to buy, sell, or hold any specific security. Investing involves the risk of loss and further risk disclosure can be obtained by reading the ETF or mutual fund s prospectus. FMD Capital Management clients may own securities mentioned in this report.