THE Decision

Dear Relaxing Retirement Member,

When your spending needs are supported by income from the work you do, you can afford to be a little more casual with your investments.

However, when your employment income “faucet” turns off, and you’re dependent on The Retirement Bucket you’ve accumulated over your lifetime to support you, being casual with your investments can lead to running out of money!

As we’ve identified over the last few weeks, everything must begin with calculating the investment rate of return you must earn in order to have your Retirement Bucket provide the lifestyle sustaining income you want without running dry.

Once you’ve arrived at your number, the next question we ask in developing The Relaxing Retirement Formula™ is where do you position your investments to produce that long term rate of return you need while experiencing acceptable levels of volatility and paying less taxes to the government?

To help you determine the correct answer for yourself, there are (4) Principles and Guidelines I recommend for you.

Last week, we tackled the first one which was knowing what NOT to invest, i.e. funds you will be spending in the short run, and thus don’t want to subject to market price volatility.

Today, let’s tackle #2.

Principle #2: THE Question

Your answer to one binary question will have more impact on your financial future than anything else. Here it is…

Once you have set aside funds to support multiple years of your anticipated future withdrawals in money markets and short term instruments, what percentage of your Retirement Bucket™ will you invest in ownership shares of quality companies (stocks) vs. fixed income investments (bonds, money markets, CDs, and fixed annuities)?

Your answer to this binary question will have the greatest impact on your ability to generate the investment returns you need.

The higher the percentage of your Retirement Bucket that you hold in ownership shares of the great companies of the world, the greater the likelihood of your Retirement Bucket being able to generate the lifestyle sustaining income you need without running dry.

The reason for this is simple: inflation!

While cash and bond returns have barely kept pace with historical inflation, thus doing a poor job of preserving your purchasing power over your anticipated lifetime, stock returns (ownership shares of great companies) have far surpassed inflation, thus doing a spectacular job of protecting your ability to produce lifestyle sustaining income.

Large cap company share returns have averaged 7% above inflation historically. Small cap stocks have returned even more.

Please stop and read that again.


Once you’ve made the decision to own companies (stocks), the next question is where will you allocate the equity (stock) portion of your Retirement Bucket, i.e.

  1. In ONE company, i.e. Apple vs. Exxon Mobil?
  2. In ONE idea, i.e. solar vs. electric?
  3. In ONE industry, i.e. technology vs. health care?
  4. In ONE asset class, i.e. small cap value vs. large cap growth?
  5. In ONE investing style, i.e. value vs. growth?
  6. In ONE region, i.e. U.S. vs. China?

If you’re going to invest your life savings in any ONE of these, you better be right! If you chose Apple when nobody else wanted it, you hit a home run. However, if you chose Polaroid or Enron, you’re bankrupt!

The challenge going into any given year is who can predict with absolute certainty what company or asset class will be the big winner.

And, if someone did have the confidence to make a bold prediction as to who this year’s winner will be, are you willing to place your lifetime savings, that now has to support you for the rest of your life, 100% into their predicted winning asset class?

I believe I know your answer already.

This is why so many of us believe in strategic diversification vs. tying 100% of your future to any ONE thing.

Another factual reason is history has demonstrated that you can achieve greater returns and experience less volatility through diversification.

Which Train Do You Need to Be On?

To help you determine which are appropriate for you, and how much of each asset class is appropriate, I recommend the analogy of “trains”.

There are some trains that move very slowly. They plod along and get to where they need to go, but at a slower pace.

There are others, on the other hand, which move much faster.

In the investment world, here’s an example of average historical rates of return (not necessarily current) for various general asset classes (trains):

  • Money Markets and CDs: 1-3%
  • Government Bonds: 35%
  • Fixed Annuities: 3-6%
  • Corporate Bonds: 5-7%
  • Large Cap Stocks: 9%
  • Mid Cap Stocks: 10%
  • Small Cap Stocks: 11%

Each of these asset classes has subsections which include: value vs. growth stocks, developed vs. emerging markets, high vs. low quality (i.e. junk) bonds, and various sectors including health care, energy, and consumer products, etc.

As you can see, some asset classes have moved more slowly and others have moved much faster. The further down the list you go, the higher the historical rate of return each has produced.

However, along with that higher return comes much higher volatility and much higher likelihood that you won’t achieve those returns in a given year.

Key words: in a given year”.

A Better Question to Ask

Going back to the investment rate of return you “need” to earn, let’s assume for a moment that you have carefully forecasted your level of Retirement Bucket Dependence into the future, and assuming a 5% inflation rate per year, you’ve calculated that you need to earn 2% above inflation, or a 7% nominal rate of return on your money in this example in order to make your Retirement Blueprint™ work, i.e. to have your investments remain intact year after year while still providing you with the lifestyle sustaining income that you want.

If you need to earn 7% (2% above inflation), can you afford to have all of our money in money markets and CDs earning 1 or 3%?

Certainly not.

Money markets and CDs have no volatility, but they also don’t provide you with a reasonable opportunity to earn the 7% you need (2% above inflation) to make your numbers work. Alone, they will not get the job done for you.

Conversely, if you only need to earn 2% above inflation (or a 7% nominal rate of return), do you need to have all your money in small cap stocks?

Certainly not again! Why subject yourself to the higher level of volatility if you don’t want or “need” to.

So, the intelligent question to ask isn’t “what’s the best investment or asset class?”

The intelligent question is how much of your money do you need to allocate to each asset class in order to produce the overall rate of return you need to earn while subjecting yourself to an appropriate and acceptable level of volatility?

To accomplish this, you’re going to ask different classes of investments to do different things.

Because of this, you can expect them all to behave differently. The key word is to expect it and not be surprised when it does.

This leads us to the 3rd Principle and Guideline which we’ll tackle shortly.

I will tell you ahead of time that Principle #3 is the one that allows you to sleep at night even during large amounts of market turbulence like we have all experienced lately.

Stay tuned.

Committed to Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)