Retirement Mistake #3: Failing to Rebalance
The last easily avoidable mistake you should watch out for is failing to rebalance your accounts on a regular basis. An absolute nightmare scenario for any retiree is to build a retirement plan based on the assumption of, say, 4% annual drawdowns … then have a major bear market put your entire standard of living at risk.
Drawdowns of 4% are no problem at all in a raging bull market that sees the market rise 10% to 20% per year. But if you go through a prolonged bear market, taking regular drawdowns can dig deeply into the capital that you need to last for the next 20 years. The best analogy would be that of a farmer who eats his seed capital and then has nothing to plant come spring.
The traditional rule of thumb for asset allocation was to have the percentage of your portfolio allocated to equities equal to 100 minus your age. So, a 70-year-old retiree should have 30% allocated to stocks and 70% allocated to bonds and cash. (Owing to longer life expectancies, some planners suggest using 120 minus your age.)
There are a couple big problems with this rule of thumb. When it was concocted, bonds yielded significantly more than they do today. A bond portfolio yielding 5% to 7% was easily obtainable 15 years ago. That’s simply not the case today.
I would advocate a more flexible approach of gradually rebalancing your portfolio away from “growth-oriented” investments to “income-oriented” investments. This would include bonds, of course. But it would also include dividend-paying stocks, master limited partnerships, real estate investment trusts and even more exotic options such as buying investment properties or pursuing a covered call writing strategy. The objective is to build a growing stream of retirement income that doesn’t require you to spend down your principal.
But one world of advice here: Be wary of exceptionally high yields, as these can often signal danger. In 2012, I wrote an article warning investors to stay away from RadioShack (RSH) and to avoid being seduced by its then-10% dividend yield, as I expected it to be cut (it was). Alas, so was the dividend of one of the stocks I offered as an alternative, Spanish mobile giant Telefonica (TEF).
This brings up a complementary point: As you rebalance your portfolio toward income-oriented investments, be sure to diversify among both companies and industries. Plenty of income investors thought they were diversified in 2008 because they owned a large number of stocks. But it didn’t matter when a disproportionate number of them were banks that all ended up slashing their dividends during the crisis.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long TEF. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.