Since I turned 50, the idea of investing for retirement has taken on significantly more relevance. Not that I plan on retiring soon, but there’s something about the big 5-0 that makes you think it might not be so far off.
When asked, I usually joke that I could afford to retire tomorrow—as long as I died the next day. Though not all that funny, the joke highlights a reality: what drives many investors' retirement planning is what they think they can afford rather than what they'd really like to do.
Current trends in the financial markets aren’t helping what people think they can afford to do. Although the market has bounced back since the crisis, current pricing is very high by historical standards, which may well constrain the returns we can realistically expect over the next 10 years. Similarly, with interest rates close to all-time lows, the returns we get from bonds may well be just as limited. What to do?
Consider the what before the how
Much of my recent research has dealt with how to limit drawdowns. If you can limit the effects of losses during market down cycles, you may be able to significantly improve both your overall returns and your chances of meeting your goals. Diversification is the best-known strategy, but there are others. Of course, there is no perfect solution—everything has costs and drawbacks.
As I think about how to build a portfolio for my ultimate retirement, though, I've been increasingly focusing on what I'm trying to accomplish and separating that from the investment process itself. We in the financial industry tend to spend the most time on the how, but it makes sense to consider the what first.
So what am I really looking for? Simply, an income stream that will support me throughout my expected lifetime (which hopefully extends beyond tomorrow). This is the ultimate goal. Then, between the income target and the time frame, I can work out what kind of returns I need to achieve to meet that goal, and whether my current savings plan will get me there.
The value of an income focus
So far, so simple. What I’ve found most useful about this exercise is that I’ve been much less concerned about the capital value of my accounts. Take the period from 2007 to 2009 as an example. If you were focused on your account values, you probably had a much different experience than if you were focused on the income you received from your portfolio, which may have changed by much less.
Over time, drawbacks are actually beneficial, as you can reinvest the income at much better valuations. The income focus, which relates to your goal, is much more useful than the capital value focus, which does not. With my own accounts, I couldn’t ignore 2008 any more than the next guy, and I was just as worried about the first quarter of this year. But by staying attuned to the strategy and the income, I was better able to set aside my concern and keep working on my goals.
I’m not entirely sure how this evolves, but the idea that reducing uncertainty allows us to stay on track toward our goals has been at the core of my research since the financial crisis. In many ways, this isn’t new—dividend income investing, which is similar to what I am thinking, is as old as the hills—but identifying why it works, as well as how it works, has been valuable to me as I consider my next steps.
Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation’s largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth’s investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by McMillan.