(Image credit: Getty Images)
Editor’s note: This is the final article in a five-part series about all-asset retirement planning that covers such topics as using lifetime annuities and housing wealth, making the most of tax benefits, and managing investment portfolio risk. See below for links to the first four articles.
In writing this series, we saved the topic of managing investment risks in a retirement plan for last. Not because it’s either least or most important, but rather, it’s an area where things could get complicated, particularly if it got into security selection or hedging strategies that go beyond our retiree’s — and even our — expertise.
The reality is we have reduced the investment risk challenge through all-asset planning even before we get to this point.
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Market volatility
Let me give you some context and background. Just as we did in the article Treat Home Equity Like Your Other Retirement Investments, we measure how investment markets perform by using the historical performance of benchmark portfolios over the past 30 years. No measure can predict the future, so we’re comfortable with historical.
During the past 30 years, the S&P 500 index has twice dropped more than 20% for the entire year. So, with, say, $1 million in the market invested in an index fund of S&P 500 stocks, that would be a more than $200,000 reduction in market value in a single 12-month period.
Now, we know stocks recover, but if you were newly retired or late in retirement, this would be very upsetting and might cause you or your adviser to pull back on stocks — and lose the opportunity to regain that market value.
This is particularly an issue if you’re liquidating a portion of your portfolio each year to fund, for instance, withdrawals/distributions (RMDs) from your IRA account.
The graphs below show the volatility of the S&P 500 using compound annual growth rates for five- and 20-year periods ending in the calendar year indicated.
(Image credit: Jerry Golden)
Note in particular how the returns tend to stabilize as the holding period lengthens. The key appears to be to “stay the course,” even in the face of adverse short-term performance.
But just as important is the understanding of how market performance could drive your plan’s results.
How an all-asset plan already reduces investment risk
Let’s see how all-asset planning has already reduced this risk — and made it more manageable. The first step in our planning is to combine the S&P 500 portfolio with a fixed income bond portfolio to create a Balanced Portfolio used in the rollover IRA account.
There is no return or tax reason to keep these investments separate for a rollover IRA account, and it also has the advantage of reporting a blended return. These graphs show the blended returns for those same five- and 20-year periods.
(Image credit: Jerry Golden)
While reducing the risk over the long term by allocating to a fixed income portfolio, there is still stock market risk.
Steps to manage the investment risk
Despite the lowering of risk with a Balanced Portfolio, your plan is impacted by the stock market returns, and you may want that risk reduced.
Here are some preliminary steps already in place in an all-asset plan and covered in our first four articles of this series.
- Include housing wealth in planning. By taking a portion of income in a HECM (home equity conversion mortgage) drawdown, you’re reducing IRA withdrawals. At the same time, you’re building up liquid savings from, say, the HECM line of credit.
- Include lifetime annuities. While taking care of longevity risk through a SPIA (single premium immediate annuity) and a QLAC (qualified longevity annuity contract), you’re reducing IRA withdrawals and, at the same time, reducing investment risk. These annuities provide fixed payments and are backed by highly rated insurance companies.
- Reduce income taxes. As described in our fourth article in this series, The 9% Solution, these first two steps in our example are reducing income taxes by as much as 50% in the first year.
- Use high-dividend portfolio for personal savings. If you’re including personal savings in your plan, using this portfolio to increase cash flow from higher dividends also benefits from lower volatility and lower tax rates on dividends.
(Image credit: Jerry Golden)
How much risk is left?
A lot of the work has already been done. For our sample investor ($1 million each in a rollover IRA, personal savings and the value of the home), about $420,000, or 14% of total net worth, is in an S&P 500 index and subject to liquidation to cover withdrawals. (If no personal savings, then it represents 21% of net worth.)
Here are two pie charts that show the allocation of all sources of income, and then focuses on those that are “safe” and not dependent on stock market performance.
(Image credit: Jerry Golden)
The charts show that for our sample investor, a 67-year-old man, 76% of the income is not based on stock market performance.
Managing risks through plan adjustments
Whatever the protections from other assets, how do we deal with any residual risk? First, here’s what we don’t do in our planning:
- We don’t use the HECM line of credit as a planned backstop for the stock market volatility. We have earmarked that for long-term care and unplanned expenses.
- We don’t accelerate the income under the QLAC — that’s already part of the planned income.
- We don’t build in hedges to protect the portfolio.
What we do is look at two time frames:
- The initial five to ten years of the plan when a sharp drop in the market could reduce your retirement savings and upset your long-term plans. That’s called a sequence of returns risk.
- A period of long-term underperformance where you literally might not have funds to cover the planned-for IRA withdrawals.
For the first time frame, we suggest thinking about allocating a portion to a money market fund. Our current model suggests an allocation into a money market fund of about two to three times the average IRA withdrawal during this initial five- or ten-year period.
This will be sufficient if we make withdrawals from the fund in adverse markets over the initial period.
Based on our early tests with historical performance, it pays for itself and, in particular, addresses the sequence of returns risk.
For the second long-term underperformance, we suggest you consider updating your plan and see how it works with an allocation of the reserve income to current income needs. This action may cut the amount you planned on for long-term care or to pay down your HECM loan to create a larger legacy. You’ll be the judge of these options.
While the elements of the all-asset plan are correct, the allocations among asset classes should be set to meet your objectives.
If you have a chronic illness, you might skip the lifetime annuity or at least elect beneficiary protection. And if you have a favorite investment opportunity beyond our planning, then exclude it from your retirement plan and possibly accept a lower income or legacy.
About the recent news regarding inflation
With the announcement last week that inflation had jumped to 3.8% in April, we thought it necessary to address the inflation risk as one that needs management.
To put it in perspective, over the 30-year period ending in December 2025, there have been 11 five-year periods where inflation exceeded a compound average of 2.5%.
One straightforward approach would be to increase the assumed inflation rate built into the plan from 2.0% to 2.5%.
With this change, our sample investor (a man age 67) with $2 million in retirement savings and $1 million in the value of his house would see starting income drop from $131,000 to $124,000.
Now, what to do about short-term inflation jumps like the current 3.8%? You can accept the inflationary adjustments as they occur. Or, to avoid any income reduction, draw on, say, the HECM line of credit or other sources of savings.
Alternatively, you could set aside a slightly larger amount in the money market fund designed for stock market volatility and draw on it when needed to deliver the higher income.
Notably, since the most recent five-year period had a compound average of nearly 4.5%, it’s smart to keep an eye on inflation.
Why now?
For decades, retirement planning has focused almost entirely on investment portfolios. The implicit assumption is that a well-diversified portfolio — managed prudently — can solve every retirement challenge.
Maybe it used to be true, but that assumption no longer holds. As suggested above, the construction of an all-asset plan can reduce the risks and the impact of adverse effects of the stock market.
Just remember, the all-asset plan is delivering the highest levels of income and liquid savings. It also has the lowest early tax rates and market risk. To find out for yourself, you can order a complimentary plan.
