The #1 Investment Challenge Moving Into Retirement

Someone who is close to retirement may be un-aware of a major challenge they’ll face when they no longer have regular earned income. The trap looming in the shadows is how to evolve an investment strategy from a growth mode to an income mode. Let me illustrate this pitfall with an example of a couple we know.

We had a casual lunch last week with this couple who both plan to retire next year. We talked about their future (travel) and hopes (first grandbaby arriving soon) and, because they’re friends and not clients, we barely touched on money issues. The husband will get a pension from the State and the wife will receive a small pension from a previous employer. She has been the chief investment officer for the couple, and I infer she thinks her portfolio has done quite well. And it might have, especially in the last ten years.

If an investor has been lucky enough to invest mostly in large U.S. stocks for the last 30 years, her average annual return would have been 10.7% according The Motley Fool. Over the last 10 years, the average annual return was 13.9%. At these rates, our friends’ portfolio doubled in value every 7 years or so, not including what the couple contributed.

Consequently, the couple may be feeling satisfied with their financial situation. Good for them. Now comes the challenging part. It’s not easy to take money out of a portfolio when (a) neither of them is bringing home paychecks every two weeks and (b) there is a substantial and prolonged market downturn. The questions this couple must answer are abundant:

• What’s the best income approach for the portfolio: dividends and interest, total portfolio, bucket approach?
• What’s the best asset allocation to use?
• When to start rebalancing the portfolio?
• What taxes liability will occur when stocks in taxable accounts are sold?
• When best to take the tax hit?
• What will be the impact of stock sales on Medicare Part B premiums?
• From which account do they start withdrawing money first?
• How much needs to be withdrawn each year considering inflation and other income floors?
• How to manage RMDs?
• Should they consider Roth IRA conversions?
• How much of the portfolio needs to be set aside for emergencies?
• When to start Social Security payments?
• Whom do they turn to when they have questions?

Both of our friends are smart and resourceful, and they will probably be able to find answers to these questions. I hope so and will help if they ask me. In the meantime, my best advice to this couple or anyone approaching retirement is to start figuring out the answers as soon as possible. A major market downturn between now and when our friends plan to retire could derail their retirement plans.