How Should I Invest Now That I’m Retired?

What’s the best way to invest your savings once you’re no longer drawing a paycheck?  Should you keep a high proportion of your investments in stocks, as you probably did while saving for retirement?  Should the rest be in bonds (wait  — aren’t they losing money right now)?  And how big an emergency fund do you need?  Read on, dear reader, for answers to these important questions.

Timeless Advice from Investment Giants

Let’s begin with a Warren Buffet tale.  (It’s fortunate he exists; if he didn’t, we would have to invent an apocryphal Warren-like character to illustrate financial truths in a folksy style.)    In 2007, he made a bet with a hedge fund manager that he could outperform a basket of hedge funds by investing in a boring, plain vanilla S&P 500 index fund.  Ten years later, the moment of truth came and the result was not close – the index fund had returned an annual average of 7.1%, while the basket of hedge funds only managed 2.2%.  His point made, Warren donated the winnings to a charity – Girls, Inc., of Omaha. 

Morality tales don’t come much clearer than this.  The winning investment strategy for most people is a simple one — diversify, keep costs low, tune out the noise and stay the course (note that the Sage of Omaha made no adjustments to his investment despite the Great Recession occurring early on).  Eliminating any doubts as to his views, Mr. Buffet revealed in one of his annual letters to Berkshire Hathaway investors that, when he dies, his bequest to Mrs. Buffet will be invested 90% in an S&P 500 index fund and 10% in government bonds.  Investing doesn’t get much simpler than this.

Buffet isn’t the only investment legend to hold such views.  To quote the recently deceased John C. Bogle, inventor and popularizer of the index fund:

“Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.” 

Index funds from places like Vanguard, Fidelity and Schwab are extremely low cost (Fidelity recently came out with zero-cost funds), and provide effortless diversification – across the entire stock market or bond market, if that’s your desire.  As Bogle (like Buffet, an excellent source of pithy quotes) has said,

 “Don’t look for the needle in the haystack. Just buy the haystack.“

Investing in Retirement – Just a Bit Different

So is investing in retirement just like investing at other stages of life?  Not quite – most of the same rules apply, but there are some differences.  Investing in retirement is trickier than investing during your working years.  You have more to protect (your life savings!) and less time and ability to recover from setbacks.  Most of us need to invest for growth, yet we want to be prudent enough to protect our hard-earned savings.  How can we do this?

At one time, advisers recommended investing 100 minus your age in stocks and the rest in bonds.  Nowadays, experts recognize that this advice (e.g., 35% in stocks at age 65) may be too conservative.  People are healthier today, and living longer lives.  The chance that at least one half of a 65-year-old couple will make it into the 90s is almost 50%.  So it makes sense to plan for a nice, long retirement – to age 95, or even 100. 

You Need Stocks – But How Many?

To make your nest egg last for 30 years or so, you need to have a substantial allocation of stocks.  But unlike when you were 35, it would probably be unwise to invest all or nearly all of your savings in stocks.  It’s simply too risky.  So what’s the right level? 

William Bengen, godfather of the safe withdrawal strategy, recommended keeping 50% to 75% of your retirement savings invested in stocks.  In fact, his 4% “safe” withdrawal level is premised on an underlying stock allocation in this range.  50 to 75% may sound high, but it is based on his analysis of historic returns from different stock and bond combinations.  He found that higher (100%) and lower (0% and 25%) stock allocations both increased risk and would have failed in at least some periods between 1926 and 1994.  Wade Pfau updated this analysis to 2018, with much the same finding. 

So — what exactly is the range of stock investments consistent with the 4% Rule?  In another article, Dr. Pfau examines this question and finds that any stock allocation between 35% and 75% would support the 4% withdrawal level, based on historic return data from 1926 to the present. 

Is there any difference between investing at these very different levels?  Indeed there is.  In the same article, Pfau calculates that the median “bequest” (amount remaining after 30 years) would be about 0.6 times the initial amount (i.e., $600,000 if one starts with $1 million) at the 35% stock level vs. 2.2 times ($2.2 million) at the 75% level.  As one might expect, the higher stock level typically results in substantially more expected growth — albeit with higher volatility and more sleepless nights along the way. 

It’s interesting to note that if the withdrawal rate is increased to just 5% over 30 years, the higher stock allocations (75% and 100% stocks) have a higher probability of success than 50% stocks (78% vs. 70%).  6% withdrawals is even more dramatic, with the success rate of a 50% stock allocation dropping under 50%, while 100% and 75% stock portfolios would still succeed 69% and 58% of the time, respectively.  Extending the 4% withdrawal analysis to 40 years gives a similar result: 75% in stocks has a 92% historic rate of success, followed by 100% stocks (89% success) and then 50% (87% success).  The typically greater growth that comes with a high stock allocation becomes increasingly important as the withdrawal rate increases or the time lengthens.  So – if you suspect you’re really going to be withdrawing at something above a 4% level, or you’re an early retiree looking at 40 or more years of retirement, or you’d really like to leave a legacy to the kids, you might lean toward the higher level.

So What’s the Bottom Line? 

As outlined above, you can reasonably invest anywhere from 35% to 75% in stocks.  Your choice will depend on your risk tolerance (don’t overestimate it and sell under duress!), age, health, and desire to leave a legacy to your heirs.  It’ a good idea to diversify further by splitting your stock allocation between a total US stock market index fund and an international index fund.  That way, you’re buying a stake in the economic growth of Europe, the fast-growing economies of Asia, emerging markets – the whole world, in fact.  Fidelity has zero-expense mutual fund and ETF versions of US and international stock indexes; Vanguard’s and Schwab’s offerings don’t cost much more.

What about the part of your portfolio that isn’t stocks?  Most of the remainder can be in bonds – all in a single total bond fund (the simplest approach), or divided among total bond, short-term bond and/or TIPS (inflation-protected securities) funds, as you see fit.  Low-cost index funds are available for all of these from Vanguard, Fidelity and Schwab. 

Alternatively, you could invest in individual Treasuries or TIPS (Treasury Inflation-Protected Securities) or longer-term CDs.  (Unlike other individual bonds, these are all guaranteed or insured by the Federal government so the default risk is close to zero.) At the moment the yield curve is flat, so there’s little reason to invest in anything with a maturity of more than 5 years.  (Longer duration bonds increase your risk but don’t give you any greater return.)  Buying individual bonds is obviously more work than buying a single bond fund; the benefit is that you can’t lose money if you hold the bond to maturity. 

I agree with most financial planners’ recommendation to keep two to thee years’ worth of expenses (that is, what you would need in a typical year after accounting for social security and other regular income) in cash.  Your cash kitty is your emergency fund for unexpected needs – such as the uninsured impacts of a flood or earthquake, a lawsuit, large out-of-pocket health care costs, or a kid who needs financial help.  It also provides a bit of a cushion to help you avoid liquidating stocks during a market downturn.  Cash can be in an online savings or money market account, or CDs (but some of it should be liquid). 

There you have it – determine your desired stock allocation and divide it between US and international index funds; invest most of the remainder in a total bond fund (or one of the other options outlined above); and keep two to three years of expenses in cash.  Review your portfolio once a year and rebalance to get back to your desired stock/bond allocation. 

This investment strategy is so simple and low-maintenance that financial writer Scott Burns memorably described a similar approach as a “couch potato portfolio.”  Many Bogleheads – thoughtful followers of Jack Bogle’s “majesty of simplicity” investment philosophy – also subscribe to this strategy, which they call the “three-fund portfolio.”

Some very smart people believe simple is best when it comes to investing.  So set up your own couch potato portfolio, relax and enjoy your retirement!

References

Bengen, William P.  (1994, August).  Determining Withdrawal Rates Using Historical Data. Journal of Financial Planning.

Burns, Scott.  (Oct. 01, 1991).  Exactly How To Be A Couch Potato Portfolio Manager.  Asset Builder.

Pfau, Wade.  (January 16, 2018).  The Trinity Study and Portfolio Success Rates (Updated to 2018).  Forbes.com

Pfau, Wade (February 7, 2012).  William Bengen’s SAFEMAX.  Retirement Researcher Blog.

Various.  (December 17, 2018).  Three-Fund Portfolio.  Bogleheads Wiki.